This year has been a banner year for cryptocurrencies, with the prices of Bitcoin
and Ethereum reaching all-time highs in November. Undoubtably,
margin trading – the borrowing of capital from a broker or a margin
lender to execute crypto trades – has played an important role in
fueling the rise in crypto prices. But even as margin trading has
become an increasingly popular strategy to boost returns, crypto
traders may have fundamental questions on the tax implications of
using margin. For example, how much gain should taxpayers recognize
if part of their position is borrowed? Is the gain capital or ordinary income? What happens
if the taxpayer exchanges a cryptocurrency, a portion of which was
bought with margin, for another cryptocurrency instead of
liquidating their positions?
This confusion is partially attributable to the lack of specific
IRS guidance on cryptocurrencies and robust
tax reporting capabilities on the part of many crypto exchanges.
Nevertheless, in light of increased efforts from Congress and the
IRS to regulate and subject crypto earnings to the federal tax
regime, crypto investors should generally be aware of the
implications of buying and selling crypto, including the use of
margin in such transactions.
Overview of Margin Trading
Before diving into the tax implications of crypto trading with
margin, a little background on margin trading is in order. When
traders buy on margin, they are essentially borrowing capital from
their brokerage or a margin lender to buy cryptocurrencies, with a
promise to repay the lender the borrowed capital and interest at an
established date. Traders are usually subject to limitations on the
amounts they can borrow, with the cryptocurrencies in the account
serving as collateral for the margin loan. As with any other loan,
taxpayers must pay interest on the margin, which can vary depending
on the brokerage/margin lender and the amounts borrowed.
Buying on margin effectively allows you to invest more capital
into a cryptocurrency, thereby amplifying the return on investment.
At the same time, margin trading can magnify your losses as well.
For example, if the price of the cryptocurrency falls below the
price you purchased it at, then you may effectively lose all or a
portion of your own capital on the sale of the cryptocurrency
because the funds must be used to repay the margin loan and
interest. In the worst-case scenario, if the value of the
cryptocurrencies in your account falls below the minimum equity
requirements of your margin loan, the brokerage/margin lender can
initiate a margin call on your loan. In such a process, the lender
will require you to deposit more funds to bring your account up to
the minimum equity requirements or initiate a sale of the
collateral (i.e., the cryptocurrencies) to repay the margin
Tax Implications of Crypto Margin Trading
As with other cryptocurrency transactions, Notice 2014-21 provides useful principles that
can be applied to crypto transactions involving the use of margin.
Under the Notice, cryptocurrencies are treated as property for
federal tax purposes. Thus, gain or loss on the sale of
cryptocurrencies is determined by taking the difference between the
adjusted basis of the currency and the amount you receive on the
sale.1 As with traditional securities, the adjusted
basis is acquisition price of the cryptocurrency (including
commissions, fees, and other acquisition costs) less certain
deductions.2 If the taxpayer held the cryptocurrency for
less than a year before the cryptocurrency is sold, any gain (or
loss) on the sale is taxed at whatever marginal income tax rate
that the taxpayer falls under.3 Conversely, if the
holding period was more than a year, any gain is subject to the
more preferential long-term capital gains rate.4
Taxpayers other corporations may deduct investment interest only
to the extent that such interest does not exceed net investment
income for the taxable year.5 “Investment
interest” means interest paid or accrued on indebtedness
properly allocable to property held for investment and generally
includes margin interest.6 Any investment interest that
cannot be deducted in a taxable year because of this limitation may
be carried forward to the succeeding taxable year.7
The principles outlined above can be applied to determine the
tax consequences of crypto transactions involving the use of
margin. More specifically, in the sections below, we will discuss
the taxation of (1) gain on sale of crypto bought with margin, (2)
losses on the sale of cryptocurrencies purchased with margin, and
(3) the exchange of cryptocurrency bought on margin for another
- Gain on sale of cryptocurrencies bought with
As mentioned above, for purposes of calculating gain on the sale
of cryptocurrency, the adjusted basis equals the acquisition price
of the currency (including certain acquisition costs). If a
taxpayer borrows capital to acquire a cryptocurrency, the amount of
such borrowed capital is included in the taxpayer’s adjusted
basis in the currency (along with any capital the taxpayer invested
himself). By way of example, suppose Tom wants to purchase $10,000
worth of Cardano tokens. He borrows $5,000 from his brokerage and
uses $5,000 of his own funds to make the Cardano investment. At the
time of purchase, his adjusted basis in the Cardano tokens is
$10,000. Tom decides to sell the Cardano tokens a month later at a
total price of $25,000. When Tom sells the coins, his brokerage
will take $5,200 of the proceeds to pay off the margin loan and
accrued interest of $200. Ultimately, Tom will recognize a $15,000
gain on the sale of the Cardano tokens, which will be taxed at
short-term capital gains rates because he would have held the
tokens for less than a year. Assuming this gain is his only
investment income in the year, Tom also will be able to deduct the
$200 interest that he paid the brokerage.
- Loss on sale of cryptocurrencies bought with
Determining the loss on cryptocurrencies bought with margin is a
little trickier. Assume the same facts as above, except that the
value of Tom’s Cardano investment declines to $7,000, at which
point he decides to sell his Cardano tokens. At the time of sale,
the brokerage takes $5,000 of the proceeds as repayment for the
margin loan, leaving Tom with $2,000 of remaining proceeds. In this
case, Tom will recognize a short-term capital loss of $3,000.
Suppose that the value of Tom’s Cardano investment drops to
$5,000, triggering a margin call from his brokerage. If Tom makes
the required deposits to bring the value of his account up to the
minimum equity requirement, there would be no taxable transaction
and Tom would have an unrealized loss of $5,000. However, if Tom is
not able or willing to make the required deposits and the brokerage
sells off the Cardano investment to cover for the margin loan, then
Tom would recognize a short-term capital loss of $5,000. Under this
scenario, Tom would effectively lose his entire $5,000 investment
in the Cardano tokens.
- Exchange of cryptocurrency bought on margin for
The exchange of cryptocurrency purchased with margin would
presumably result in similar tax consequences as described above.
This is because such an exchange triggers a taxable transaction
under Notice 2014-21. Thus, assume again that Tom uses $5,000 of
his own funds and $5,000 of borrowed capital from his brokerage to
acquire $10,000 worth of Cardano tokens. If Tom exchanges the
Cardano tokens for Ether coins when the value of his investment
climbs to $25,000, the brokerage will presumably apply $5,200 worth
of the Cardano investment to repay the margin loan and accrued
interest. Tom would recognize a gain of $15,000 and his basis in
the Ether tokens would be $20,000 ($25,000 exchanged value less
$5,000 used to repay the margin loan). Conversely, if the value of
Tom’s Cardano investment declines to $7,000 at the time of
exchange, the brokerage will similarly use $5,000 of Tom’s
investment to repay the margin loan. Tom will recognize a loss of
$3,000 and his basis in the Ether investment will be $2,000.
Margin trading has played an important role in fueling the rise of
crypto prices this year. Given that the use of margin can
significantly affect the gain (or loss) on the sale of
cryptocurrencies, traders should be generally aware of the tax
implications on crypto margin trading, especially in light of
increased scrutiny from the IRS and Congress.
1. I.R.C. § 1001.
2. See I.R.C. §§ 1011,
3. See I.R.C. §§ 1221,
4. See I.R.C. §§ 1(h), 1221,
5. I.R.C. § 163(d)(1).
6. See I.R.C. § 163(d)(3)(A);
Miner v. Comm’r, T.C. Memo 2003-39.
7. I.R.C. § 163(d)(2).
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