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orbir
New Member

Cryptocurrency arbitrage - how to calculate gains?

I'm trying to figure out how to correctly calculate taxes in the below situation.

Prices of cryptocurrencies can vary between exchanges, based in different countries. Here’s the description of a typical arbitrage trade:

Step 1: Person A buys 1 bitcoin (BTC) for 10,000 USD in the United States.

Step 2: Person A transfers 1 BTC to Person B, who lives in a different country, and is able to sell BTC on a different exchange in that country for a higher price.

Step 3: Person B sells 1 BTC in that other country for 11,000 USD.

Step 4: Person B withdraws 11,000 USD to their bank account, and wires that money over to Person A in the US through regular bank wire.

 

The total gain on this trade is 1,000 (less commissions, wiring fees etc.). How much gain does Person A and Person B, respectively, need to report?

  • If person A reports the entire gain, what happens if the tax authority in Person B’s country says they also need to pay taxes, since they got BTC that was purchased for 10,000 and they sold it for 11,000? In this case the gain would be double-taxed.
  • Can Person A and B enter into an agreement that the initial investment of 10K, and all subsequent gains are shared between them equally, and they would each report 50% of the gains, to avoid double taxation?


1 Best answer

Accepted Solutions
Opus 17
Level 15

Cryptocurrency arbitrage - how to calculate gains?

Don't do it that way, you'll get screwed if the IRS ever audits you.  That's treated as a couple of gifts, which screws up your basis.  Since there isn't a recognized way to have a bitcoin agent sell it for you in another country while you retain ownership (unlike a stock broker) this looks like gifts and tax evasion, on top of the already-tricky world of cryptocurrency.

What should happen is, you buy for $10,000 and sell for $11,000; you have a $1000 gain which is reported as a capital transaction on schedule D and taxed as ordinary income if held for one year or less, or long term capital gains if the coin was held for more than one year.

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*

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5 Replies
Opus 17
Level 15

Cryptocurrency arbitrage - how to calculate gains?

Don't do it that way, you'll get screwed if the IRS ever audits you.  That's treated as a couple of gifts, which screws up your basis.  Since there isn't a recognized way to have a bitcoin agent sell it for you in another country while you retain ownership (unlike a stock broker) this looks like gifts and tax evasion, on top of the already-tricky world of cryptocurrency.

What should happen is, you buy for $10,000 and sell for $11,000; you have a $1000 gain which is reported as a capital transaction on schedule D and taxed as ordinary income if held for one year or less, or long term capital gains if the coin was held for more than one year.

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
Opus 17
Level 15

Cryptocurrency arbitrage - how to calculate gains?

See, technically what you are doing is this:
Person A buys BTC for $10,000 and gifts is to person B.
Person B's cost basis is $10,000; if they sell it for $11,000, they owe whatever tax they owe in their home country.
Person B gifts $11,000 (or $10,500 if you like) to person A.  Since gifts are not taxable to the recipient, person A owes no income tax.

In other words, a classic tax-avoidance scheme that is highly illegal and has sent more than one person to prison (when the amounts are larger, of course).

And since bank and wire transfers of more than $10,000 are automatically reported to the IRS, there is no hiding this.  (And splitting it into multiple transactions of less than $10,000 to avoid reporting is an entirely separate crime called "Structuring.")

Potentially you could enter into some kind of agency agreement where you remain the owner and you pay the agent a commission, but that would require attorneys knowledgeable in the law in both countries.
*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
orbir
New Member

Cryptocurrency arbitrage - how to calculate gains?

Thanks, that's very helpful. So Person A reports all the gains. From the point of view of Person B, is it a reasonable statement that Person B, if asked, can claim that they had no profits on this transaction, since the effective cost basis of the BTC, measured in their country at the time of receipt was actually not $10,000, but $11,000? (That's why the whole arbitrage works).
Opus 17
Level 15

Cryptocurrency arbitrage - how to calculate gains?

I can't give tax advice in another country.

Under US tax law, bitcoin and other virtual currencies are treated as property, similar to collectibles, comic books, paintings, or other valuable physical objects.  When you sell property, you have a gain if the selling price is more than the cost basis.  For something you buy, the cost basis is what you paid.  For something you receive as a gift, the cost basis is not the fair market value on the date of the gift, rather, the cost basis is the cost basis of the original owner/purchaser.

So under US tax law, if person A gives a gift to person B that person A paid $10,000 for, and person B sells it for $11,000, then person B has $1,000 of taxable income, no matter what the fair market value of the gift happened to be in the mean time.

Assuming the laws of country B are similar, that's why the scheme is problematic.  Country B will view person B as not paying their correct income tax, and country A will view person A as being involved in a tax avoidance scheme.

The correct way to do this is some kind of agency agreement.  If you sell a painting via Sothebys in London, you don't *give* them the painting, you retain ownership, they act as agent and collect a commission, which is their taxable income, and the rest is your taxable income.  There are obviously ways to do currency arbitrage with "real" currencies where the trader pays the tax and the agent gets a commission, but I can't begin to tell you how to set that up.
*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
maglib
Level 10

Cryptocurrency arbitrage - how to calculate gains?

As bitcoin is property every transaction is a reportable transaction.  The moment you moved the bitcoin to Person B you had to report the income.  It wouldn't have mattered what it was for, even if you moved it just to move it to another exchange or ccy to ccy.  So you had a $1,000 gain on that move as the exchange rate there was a value of $11k that you were receiving.

Additionally, Now if person B then gifted you $11,000 then you have possible gift tax reporting if the amount went over $14,000 in total.

Remember the IRS considers bitcoin property, so regardless of what you did with it, there is a reporting at the exchange rate or for the value received at the time of the move.

https://www.irs.gov/pub/irs-pdf/p544.pdf and  https://www.irs.gov/pub/irs-pdf/i8949.pdf  are the IRS rules for property and reporting.  Personal property net losses are not deductible but investment property is....  follow the IRS guidelines for property.

IRS guidance on cryptocurrency as property:

https://www.irs.gov/newsroom/irs-virtual-currency-guidance 

https://www.irs.gov/pub/irs-drop/n-14-21.pdf 

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