The reclassification of your activity necessitates a tax event, which is addressed in section 70-30 of the Income Tax Assessment Act 1997:
⚖️ Tax Law (1) If you start holding as trading stock an item you already own, but do not hold as trading stock, you are treated as if: (a) just before it became trading stock, you had sold the item to someone else (at arm's length) for whichever of these amounts you elect: - its cost; - its market value just before it became trading stock; and (b) you had immediately bought it back for the same amount.
In short, you can imagine that your investment asset was instantly sold and used to purchase back the same asset from yourself, but in this case you bought it back as trading stock.
When reclassifying an investment asset to trading stock, you actually have a choice on the tax treatment. You get to choose whether the disposal happens at cost or at market value.
Tax optimisation opportunity
Whenever there is choice, there is also opportunity for tax planning and tax optimisation. You will need to decide whether it is preferable to elect the cost method or the market value method. This election can be made for each asset involved, so a combination of elections is also possible.
Choosing the cost will usually make sense when the market value of the CGT asset has gone up from when it was first acquired. By electing the cost, you will avoid having to realise a capital gain due to the increase in value.
Market value election
Choosing the market value will usually make sense when the market value of the CGT asset has gone down from when it was first acquired. By electing the market value, you can realise and claim the capital loss due to the decrease in value of the asset.
It’s important to note that if the reclassification event results in a capital loss, it must still be used to offset a capital gain. The capital loss is not converted into a revenue loss due to the reclassification event.
Sometimes, even if the market value of the CGT asset has gone up, you may still want to choose the market value method despite the resulting capital gain. That may come as a surprise but consider the following:
When the crypto is a CGT asset that is held longer than 12 months, it will result in capital gains that are eligible for the 50% CGT discount.
When the crypto is held as trading stock, it will result in ordinary income that is not eligible for the 50% CGT discount.
Capital gains that are eligible for the CGT discount are more attractive than ordinary income generated from trading stock, due to the 50% CGT discount.
That means it may be better to capture the increase in market value as a capital gain immediately, while you are still eligible for the 50% CGT discount.
Making a decision
You can use this flowchart to help choose which tax election to make when converting a CGT asset into trading stock.
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Section 70-30 of the Income Tax Assessment Act 1997
The information in this article reflects our understanding of existing legislation, proposed legislation, rulings and other tax law, as at the date of issue. In some cases, the information has been provided to us by third parties. While it is believed the information is accurate and reliable, this is not guaranteed in any way.
The information provided in this article is purely factual in nature and does not constitute tax advice, financial product advice or legal advice. The information is not, nor is it intended to be, comprehensive or a substitute for professional advice on specific circumstances. If you require professional advice that takes into account your particular circumstances, you should consult an appropriate professional.
Crypto investors in Australia have disposals of crypto treated as capital gains, while traders have their crypto treated as trading stock. These are distinctly different tax treatments in Australia and have important differences in the resulting tax implications that should be considered.