Crypto on Foreign Exchanges Tax Rules

Introduction

Many crypto investors hold their assets on foreign exchanges for a variety of reasons, including access to different cryptocurrencies, lower fees, or better trading platforms. However, storing crypto on a foreign exchange introduces several important tax and legal considerations. While these exchanges may offer convenience and greater access to global markets, they also come with additional reporting obligations, potential tax exposure, and risks associated with the location of your assets. Understanding how holding crypto in a foreign exchange affects your tax filings and compliance with US tax laws is crucial for maintaining good standing with the IRS and avoiding costly penalties.

Tax Implications of Holding Crypto on Foreign Exchanges

The IRS treats cryptocurrency as property for tax purposes, which means that holding crypto, whether on domestic or foreign exchanges, has tax consequences.
While holding crypto in a foreign exchange may seem like a passive activity, several tax obligations arise when transactions occur, including:

• Capital gains taxes: When crypto is sold or exchanged, the IRS requires you to report any gains or losses.
• Income reporting: If you earn crypto from staking, mining, or interest, that income is taxable and must be reported.

How the IRS Views Crypto on Foreign Exchanges

The IRS does not distinguish between domestic and foreign exchanges when it comes to reporting crypto transactions. The key factor is that crypto transactions must be reported accurately, regardless of where they occur.
This means that even if you hold crypto in a foreign exchange or a non-US wallet, the IRS expects you to:

• Report the gains and losses from any transactions
• Convert foreign exchange transactions into US dollars
• Maintain records of all foreign transactions and crypto holdings
• Report foreign financial accounts if they meet certain thresholds

Foreign Bank Account Reporting Requirements

If you hold crypto in a foreign exchange and the total value of your foreign accounts exceeds the reporting threshold, you may be required to file FinCEN Form 114, also known as the 

Foreign Bank Account Report (FBAR).
In addition to the FBAR, Form 8938 may also be required for reporting specified foreign assets, including cryptocurrency holdings.
Both forms must be filed separately from your regular tax return, and penalties for non-compliance can be substantial. It is crucial to stay compliant with these reporting requirements to avoid costly fines or penalties.

Impact of Foreign Exchange Fees and Transactions

Fees paid to foreign exchanges for trading, withdrawal, or conversion services can impact your taxable gains and losses.
For example, the cost of transferring crypto between exchanges or converting between tokens may not be immediately obvious, but these fees contribute to your cost basis and affect the overall gain or loss calculation.
While foreign exchange fees themselves are not directly taxable, they must be accurately factored into the overall calculation of your taxable events. Incorrectly reporting these fees can result in inaccurate gains reporting and IRS penalties.

Using Foreign Exchanges to Avoid US Taxes: Risks and Reality

Some crypto holders may assume that storing or trading crypto on a foreign exchange allows them to avoid US tax rules. However, this is a misconception.
The IRS does not distinguish between exchanges based on location, and as long as you are a US taxpayer, you are required to report any gains, losses, or income generated from foreign exchanges.
While some foreign exchanges may not report to the IRS directly, taxpayers are still bound by US tax law and are required to report their crypto transactions accurately.

Taxable Events Triggered by Foreign Exchange Transactions

A taxable event is triggered when you:

• Sell or exchange crypto: Whether on a foreign or domestic exchange, selling or trading crypto for another asset (such as a different cryptocurrency or fiat currency) triggers a taxable event.
• Convert to fiat: Converting crypto to fiat currency (such as USD, EUR, etc.) is a taxable transaction.
• Receive interest or rewards: Crypto earned from staking, lending, or rewards is considered income and is subject to tax.
• Transfer crypto for goods or services: Using crypto to pay for goods or services is a taxable event, as you are deemed to have sold the crypto at its fair market value.

Reporting Gains from Foreign Exchanges

When reporting gains from foreign exchanges, you must:

• Convert all transactions to US dollars using the exchange rate at the time of the transaction
• Maintain records of each transaction, including date, transaction type, amount, and value in US dollars
• Report capital gains and losses on Form 8949
• Include the total on Schedule D to summarize your gains and losses from all crypto transactions, including those from foreign exchanges
  If you are using multiple foreign exchanges or wallets, accurate tracking of all transactions across platforms is essential to maintain compliance.
   

Challenges with Foreign Exchange Compliance

One of the primary challenges with foreign exchanges is the lack of direct reporting to the IRS. Unlike US exchanges, which are required to report user activity to the IRS under Form 1099, foreign exchanges are not bound by these same reporting requirements.
This means that you are responsible for tracking your own activity and ensuring you report all taxable events. Failure to report income or gains from foreign exchanges can result in penalties or legal issues.

The Risk of Losing Control Over Crypto

While holding crypto on a foreign exchange may offer convenience, it also means that you are entrusting your assets to an exchange located outside of the US jurisdiction.
Exchanges may experience:

• Security breaches: Hacks or breaches can lead to the loss of assets, and there may be little recourse to recover stolen funds.
• Regulatory uncertainty: Foreign exchanges may not have the same legal protections as US-based exchanges, leaving users at risk of sudden regulatory changes.
• Withdrawal restrictions: Some exchanges may impose limits on withdrawals or freeze accounts due to regulatory concerns, making it difficult to access funds when needed.

The Importance of Recordkeeping for Foreign Crypto

Maintaining accurate records of all transactions and holdings in foreign exchanges is critical for tax compliance.
Taxpayers should track:

• All deposits and withdrawals
• The date of transactions
• Conversion rates
• Transaction fees
• The amount of crypto held in foreign exchanges at year-end

Crypto tax software can assist in organizing this data and producing the required forms for tax filing. Proper recordkeeping is essential for supporting your claims and avoiding discrepancies during IRS audits.

Conclusion

Holding crypto in a foreign exchange can lead to significant tax complexities. While there may be no immediate tax obligations while simply holding assets, any movement of crypto on the exchange—whether through sales, trades, or conversions—triggers taxable events. The IRS treats foreign exchanges the same as US-based exchanges for reporting purposes, requiring US taxpayers to report worldwide crypto activity.
To avoid penalties, taxpayers must track their foreign exchange activity, report gains and losses, and file the necessary forms for foreign account reporting. Staying compliant and managing foreign exchange transactions effectively ensures that crypto activities remain transparent and legally sound.

Tax Partners can assist you with navigating the complexities of foreign exchange reporting, ensuring accurate tax filings, and creating a strategy that minimizes tax liabilities and supports long term compliance.

This article is written for educational purposes.

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at info@taxpartners.ca, or by visiting our website at www.taxpartners.ca.

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