Crypto Derivatives - Options, Futures & Understanding Taxation

Crypto derivatives, such as options and futures, are financial instruments that allow traders to speculate on the future price movements of cryptocurrencies. While these instruments can be useful for hedging risks and generating profits, they can also have complex tax implications. 

In this article, we will explore the taxation of crypto derivatives, including options and futures.

Concept of Cost Basis

Cost basis refers to the original cost or value of an asset, such as a stock, bond, or real estate property. It is used to determine the amount of capital gain or loss when the asset is sold or exchanged. In other words, the cost basis is subtracted from the sale price to calculate the gain or loss.

For example, let's say you purchased 100 shares of XYZ stock for $10 per share, which would give you a cost basis of $1,000. If you later sell those shares for $15 per share, your total proceeds would be $1,500. To determine your capital gain, you would subtract your cost basis of $1,000 from your proceeds of $1,500, resulting in a capital gain of $500.

It is important to keep accurate records of your cost basis, as it can affect the amount of taxes you owe on your investments. For example, if you sell an asset for a loss, you may be able to use that loss to offset gains on other investments, thereby reducing your overall tax liability.

Use our crypto tax calculator to calculate your taxes easily.

Crypto Options Taxation

Crypto options are contracts that give the buyer the right, but not the obligation, to buy or sell a specific cryptocurrency at a predetermined price on or before a specific date. These contracts can be used for speculation or hedging purposes, and they can be settled in cash or the underlying cryptocurrency.

The taxation of crypto options depends on whether they are considered to be capital assets or not. If the options are considered to be capital assets, then any gains or losses from the sale or exercise of the options will be subject to capital gains tax. The tax rate for long-term capital gains (assets held for more than a year) depends on the taxpayer’s income, but it can be as high as 20%. Short-term capital gains (assets held for a year or less) are taxed at the taxpayer’s ordinary income tax rate.

If the options are not considered to be capital assets, then any gains or losses will be treated as ordinary income or losses. This means that they will be subject to the taxpayer’s ordinary income tax rate, which can be as high as 37%.

One important thing to note is that the taxation of crypto options can be complex, especially if they are settled in the underlying cryptocurrency. In this case, the taxpayer will need to calculate the fair market value of the cryptocurrency at the time of exercise or settlement, which can be a difficult task given the volatility of the crypto markets.

Crypto Futures Taxation

Crypto futures are contracts that obligate the buyer and seller to buy or sell a specific cryptocurrency at a predetermined price on a specific date in the future. These contracts can be used for speculation or hedging purposes, and they are settled in cash.

The taxation of crypto futures is similar to the taxation of traditional futures contracts. Any gains or losses from the sale or exchange of futures contracts are treated as capital gains or losses, depending on whether the contracts are considered to be capital assets or not.

If the futures contracts are considered to be capital assets, then any gains or losses will be subject to capital gains tax. The tax rate for long-term capital gains (assets held for more than a year) depends on the taxpayer’s income, but it can be as high as 20%. Short-term capital gains (assets held for a year or less) are taxed at the taxpayer’s ordinary income tax rate.

One important thing to note is that the taxation of crypto futures can be complex, especially if the contracts are settled in cash. In this case, the taxpayer will need to calculate the fair market value of the cryptocurrency at the time of settlement, which can be a difficult task given the volatility of the crypto markets.

For example, if an investor buys a Bitcoin futures contract for $10,000 and it is worth $12,000 at the end of the tax year, the investor would realize a $2,000 gain, which would be taxed as either short-term or long-term capital gains depending on how long the futures contract was held.

On the other hand, if the Bitcoin futures contract is worth $8,000 at the end of the tax year, the investor would realize a $2,000 loss, which can be used to offset other capital gains or up to $3,000 of ordinary income.

It's important to note that futures contracts are subject to a 60/40 tax split, which means that 60% of any gains or losses are taxed as long-term capital gains/losses, and 40% are taxed as short-term capital gains/losses, regardless of the length of time the futures contract was held.

Tax on Swaps and Forwards

When it comes to crypto derivatives, such as swaps and forwards, the tax implications can also be complex. For example, in the United States, the IRS has classified certain types of crypto derivatives as swaps, which are subject to special tax rules. These rules may require investors to mark-to-market their positions each year, which can result in taxable gains or losses even if the position has not been closed.

Overall, it is important for investors to understand the tax implications of their investments, including the impact of cost basis, wash sales, straddles, and other transactions. Consulting a tax professional can be helpful in navigating these complex issues.

Wash Sales and Straddles

Wash sales and straddles are two transactions that can affect an investor's tax liability. A wash sale occurs when an investor sells a security at a loss and then repurchases the same or a substantially identical security within 30 days before or after the sale. The loss from the sale is disallowed for tax purposes, and the investor must adjust their cost basis in the repurchased security.

A straddle is a transaction that involves offsetting positions in two different securities, such as buying a call option and selling a put option on the same underlying stock. The tax implications of a straddle can be complex, as gains and losses from the two positions may offset each other, resulting in a deferral of taxes.

Wash sales and straddles are two types of transactions that can have significant tax implications for crypto derivatives traders.

• A wash sale occurs when a trader sells a security (including a crypto derivative) at a loss and then buys the same or substantially identical security within 30 days before or after the sale. In this case, the loss is disallowed for tax purposes, and the trader’s basis in the new security is adjusted to reflect the disallowed loss.
• A straddle occurs when a trader holds offsetting positions in two or more securities (including crypto derivatives) that are designed to minimize the risk of loss. In this case, any losses from one position can be used to offset gains from another position, which can reduce the trader’s tax liability. However, the IRS has strict rules governing straddles, and traders who engage in straddle transactions may be subject to additional reporting requirements and penalties.

Tax Planning Strategies

Now that we've covered the basics of how crypto derivatives are taxed, let's take a look at some tax planning strategies that investors can use to minimise their tax liability.

Tax Losses: If an investor has realised capital gains in a given tax year, they can offset those gains by selling investments at a loss. This strategy is known as tax-loss harvesting and can help reduce the investor's overall tax liability.

Hold for Long-Term Capital Gains: As we mentioned earlier, long-term capital gains are taxed at a lower rate than short-term capital gains. If an investor plans to hold a crypto derivative for more than a year, they may be able to benefit from a lower tax rate by holding it for the long term.

Maximise Retirement Contributions: Contributions to retirement accounts such as IRAs and 401(k)s are tax-deductible and can help reduce an investor's taxable income. By maximising contributions to these accounts, investors can reduce their overall tax liability.

Consult a Tax Professional: Finally, it's always a good idea to consult with a tax professional who can provide personalized advice based on an investor's specific tax situation. Tax laws and regulations are complex and constantly changing, so it's important to work with someone who can help navigate the tax landscape.

Conclusion

In conclusion, the taxation of crypto derivatives, such as options and futures, can be complex and can vary depending on several factors, including whether the contracts are considered to be capital assets, how they are settled, and whether the trader engages in wash sales or straddles.

Therefore, traders need to consult with a tax professional to ensure that they are complying with all applicable tax laws and regulations. By understanding the taxation of crypto derivatives, traders can minimize their tax liability and maximise their profits.