Tax season is quickly approaching, and our cryptocurrency tax accountants are here to help you through the cryptocurrency tax filing process. As the world of cryptocurrency changes by the day, it can be daunting to keep up with all of the rules and regulations regarding cryptocurrency taxes.
Wrapped cryptocurrency tokens are becoming increasingly popular as investors use cryptocurrencies across different blockchains or as collateral in different smart contracts. As such, you may be wondering what exactly a wrapped token is and whether it is taxable. Here’s what our experts at Founder’s CPA want you to know.
What Is a Wrapped Crypto Token?
If you’re familiar with cryptocurrencies, you know that they can exist on different blockchains. Only certain types of cryptocurrencies can be used on particular blockchains—for example, you cannot trade native Bitcoin on Ethereum’s network and you cannot trade Ethereum on Solana’s network. This is where wrapped tokens come into play, allowing investors to use a diverse range of coins on different blockchains.
Simply put, a wrapped token is a tokenized version of another type of cryptocurrency that’s tied to the value of the represented asset. Take Wrapped Bitcoin, for example (WBTC). If you have one WBTC, its value is the same as one BTC as it is tied to Bitcoin’s value. When the value of the Bitcoin changes, the value of the Wrapped Bitcoin will change in conjunction.
Wrapped tokens operate in a similar way to stablecoins except stablecoins are pegged to the value of a fiat currency such as USD. On the other hand, wrapped tokens are tied to the value of a cryptocurrency that exists on another blockchain.
The Purpose of Wrapped Tokens
Those with wrapped tokens can use non-native assets on the blockchain of their choosing. Many opt for wrapped assets to help build networks of interoperability in the world of cryptocurrency, representing anything from crypto assets to commodities to equity and stocks.
Tax Implications for Wrapping Tokens
Wrapped tokens are no different from other newer phenomena on the cryptocurrency market in the sense that we do not have clear definitive guidance on how to treat these transactions.. The conservative approach is to assume that wrapped tokens shouldn’t be treated differently than other types of cryptocurrencies when it comes to tax filings, meaning wrapping a token (i.e. converting ETH to wETH) is a taxable transaction. However, there may be a stance that can be taken that would not treat wrapping crypto assets as a taxable transaction. We recommend speaking with your cryptocurrency tax accountant to discuss your options..
Capital Gains Taxes
You can expect to pay capital gains tax on cryptocurrency profits when you dispose of the underlying asset that you are wrapping. As a reminder, crypto dispositions are taxed when you::
- Spend crypto
- Swap crypto for crypto
- Sell crypto for fiat
- Give crypto as a gift
Wrapping a coin means you’re exchanging one crypto for another, and this is viewed as disposal. The same holds true for when you unwrap your coin as you are exchanging one crypto for another. It is only the profit from these transactions that result in capital gains tax.
Let’s say you bought 1 BTC for $20,000 and exchanged it for one WBTC when the fair market value of BTC was $40,000. This means your capital gains tax is $20,000 (either at short term or long term rates, depending on your holding period). If possible, avoid using assets that have increased in value when wrapping your crypto.
Contact Our Cryptocurrency Tax Accountants Today
The nuances of reporting your cryptocurrency taxes can be overwhelming. With one of our professionals on your side, we can help eliminate the stress and ensure that your taxes are filed properly. contact us today to request a free consultation!