How To Use Leverage in Cryptocurrencies And Take a Tax Deduction
Since assets are never taxed before you sell it, it makes sense to use some of your cryptocurrency as collateral to borrow cash. This way you gain liquidity without incurring a current tax bill. It is not without risk of course. According Accounting Today Digital currencies are price volatile and vulnerable to theft by hackers.
Borrowers seem eager to leverage crypto profits into cash. Cryptocurrency lenders report increased volumes, with Genesis Capital handing out loans of more than $1.1 billion and Nexo reportedly lending out $330 million since launching in August 2018.
Nexo is a Swiss-based company with affiliates in Delaware, the Cayman Islands, and Estonia, conducts its lending business from their office in London, England.
What The ‘Experts’ Say
Conventional lending experts consider the digital-lending environment risky. Lenders often abruptly appear in the market connected to global networks of affiliates and subsidiaries with a patent lack of transparency and evasive responses to queries ad to where and how the borrower’s digital currencies are stored and protected against hackers. It certainly seems risky.
The risks seem obvious. Whenever you leverage a loan on risky underlying assets, you are entering the danger zone. To add fuel to the fire, these global lenders are free from SEC, and CFTC oversight and those that admit to regulation are governed by non-banking oversight agencies. Moreover, the SEC is mute on crypto-backed cash loans.
Bitcoin gained value from $1,300 in April 2017 to $19,100 in December 2017, providing huge gains for early investors that could be used as collateral for cash loans. However, what goes up, must come down again, or so the adage warns, and since December 2017 the market bottomed out before surging back to about $4,100 in recent days.
The Loans and Tax Consequences
To carry the risk of volatility the borrower provides between 20 and 50% more cryptocurrency than they borrow, for loans from $500 to $ 2 million, for periods of up to a year. Interest rates vary greatly, and peak at about 16%.
If the prices of the cryptocurrency fall during the period of the loan, the borrower has to provide more collateral, or the crypto will be sold. In the meantime, the lender also has the option to secretly lend out the pledged cryptocurrency, something the IRS would probably consider as a sale taxable to the original owner who pledged it as collateral.
Where Are The Lenders Keeping My Pledged Currency?
According to reports, some lenders are depositing the collateral at regulated custodians like PrimeTrust, but not all lenders do this. The SEC is investigating SALT Lending for example, in respect of $50 million in ‘digital tokens’ they sold to borrowers.
It seems that the borrowers are those who gave up on their dream of a virtual currency for the lure of cash, and the borrowing craze is partly driven by creative market making by lenders who argue that the tax perks provided could even benefit investors who made significant paper losses on their cryptocurrency.
The Lending Pitch and Tax Advantages
According to Zac Prince of Block, one strategy to benefit even after making paper losses would be to sell, then to repurchase the currency, and to then borrow against it. According to Prince, this would trigger a deductible loss of about $3,000 per year for the investor while holding on to the currency for long enough to reach the capital gains rate of 20% down the line.
Another point the lenders make is that this form of borrowing is free from credit-scoring. This has been the way executives have been leveraging their equity assets into cash without selling it and paying capital gains taxes, for a long time.
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