Navigating the complexities of crypto taxation in the UK is crucial for informed investment decisions. We delve into how investors can offset cryptocurrency losses against capital gains, the rules governing such offsets, and best practices to remain compliant with HMRC regulations.
This guide is part of our series: UK Crypto Tax.
Basics of Crypto Taxation in the UK
In the UK, the HM Revenue and Customs (HMRC) categorises cryptocurrencies as taxable assets. This means that when you trade or sell crypto, you might incur a tax liability.
The type of tax depends on the nature of the transaction.
Primarily, crypto earnings can be subject to either capital gains tax, which applies when you profit from selling an asset that’s increased in value, or income tax, applied when you receive cryptocurrencies as payment for services or from mining operations.
Additionally, UK taxpayers benefit from yearly tax-free allowances for Capital Gains Tax and Income Tax. Learn all about it here: Crypto Tax-Free Allowances
Furthermore, your crypto transactions might be considered trading activity (trade as in business) by HMRC, in which case income tax applies. While this is a rather rare case, it does happen.
Read more about the distinction between hobby and professional crypto trading: Are you a crypto investor or trader?
For the purpose of this article we’re assuming that you are an investor in crypto assets and not a trader.
Understanding Capital Gains and Losses
Capital gains arise when you sell a cryptocurrency for more than its purchase price, while capital losses occur when you sell for less than the acquisition cost. Every crypto transaction, whether buying, selling, or trading, can result in either a gain or a loss.
The formula for calculating a capital gain or loss is pretty simple:
Capital Gain (or Loss) = Selling Price – Cost Basis
A positive result constitutes a gain while a negative result constitutes a loss. Learn more about calculating your cost basis: Crypto Cost Basis Methods
Due to the volatile nature of cryptocurrencies, prices can fluctuate rapidly, leading to significant gains or losses in short periods. Consequently, maintaining detailed records isn’t just a recommendation—it’s vital to ensure accuracy in your tax submissions and to safeguard against potential audits.
Crypto losses: realised losses vs. unrealised losses
Realised and unrealised losses are financial concepts describing the disparity between an asset’s purchase price and its current market value.
A realised loss arises when you sell your cryptocurrencies at a price lower than what you initially paid. This loss is “realised” because, by selling, you’ve officially taken the hit, regardless of whether you exchanged the cryptocurrency for fiat money or another digital asset.
An unrealised loss, on the other hand, is theoretical. It exists when your cryptocurrency’s market value drops below your purchase price, but you haven’t sold it. This “paper loss” persists in your portfolio until you either sell the asset or its value rebounds.
Which types of losses can you claim on your tax return?
Claiming realised losses on trading activity
In the UK, if you’ve sold cryptocurrency for less than its purchase price, you can claim this as a realised loss on your tax return. This reduction can offset other capital gains, potentially reducing your tax liability for the year. Be sure to diligently record all of your transactions for reliable cost basis calculations.
Claiming losses on lost or stolen crypto
HMRC doesn’t recognize lost or stolen cryptocurrencies as capital losses, since you are still the rightful owner and no actual disposal happened. However, there’s a provision for a negligible value claim if you can prove permanent loss of access.
Claiming losses on frozen funds
There’ve been a few bankruptcy proceedings from major cryptocurrency service providers like FTX leaving hundreds of thousands of investors with frozen funds.
Unfortunately, there isn’t a lot these affected investors can do.
Since there’s a potential, albeit small, chance of recovering these funds, HMRC doesn’t typically allow for immediate claims.
Investors are advised to wait for the proceedings to conclude. If no funds are returned after such processes, a negligible value claim might then be permissible, which can be used to offset against future gains.
Claiming losses on rug pulls
Rug pulls, where developers abandon a project taking investors’ funds, present a unique scenario in terms of capital losses.
After such events, investors often remain in possession of their tokens, meaning that it isn’t automatically treated as a capital loss – even though the value and use of the tokes have already vanished.
To realise a loss that can be claimed on your crypto tax return and offset against gains, investors need to dispose of these tokens.
Here are several ways to do this:
- Selling on Exchanges: If your tokens are still listed, the most straightforward method is selling them on an exchange.
- Swapping Tokens: For delisted tokens, using a native or non-custodial wallet might allow you to swap them for a different cryptocurrency.
- Gifting Tokens: You can gift the tokens to someone other than your spouse (gifting to a spouse isn’t a taxable event!) to realise the loss.
- Burning the Tokens: If none of the above options are viable, sending the tokens to a burn wallet, effectively destroying them, can also create a capital loss.
In the rare case where an entire blockchain is halted following a rug pull, a negligible value claim might be the most appropriate recourse.
Claiming losses on worthless NFTs
NFTs, or Non-Fungible Tokens, have gained immense popularity as unique digital assets representing art, collectibles, or other forms of value. However, just like other assets, the value of NFTs can fluctuate, and some might become worthless over time.
For tax purposes, simply owning a worthless NFT isn’t sufficient to claim a capital loss. Instead, the NFT must be disposed of to realise and claim the loss. Here are some steps you can take:
- Selling the NFT: Even if the NFT’s value has plummeted, you can attempt to sell it on the marketplace for a minimal price. This sale, even at a significant loss, will help you realise the capital loss.
- Gifting the NFT: Similar to other crypto tokens, you can gift the NFT to someone other than your spouse, which allows you to dispose of the asset and realise the loss.
- Burning the NFT: Some NFT platforms offer the option to ‘burn’ or permanently delete the NFT. By burning, you’re essentially verifying the NFT’s worthlessness and disposing of it, which can help in realising the capital loss.
Learn more about the tax treatment of NFTs: NFT Taxes
What costs can be claimed?
When determining a cryptocurrency loss, specific expenditures can be deducted:
- Initial Investment: The fiat currency amount initially used to purchase the cryptocurrency.
- Pre-Blockchain Transaction Fees: Costs incurred before the transaction gets recorded on a blockchain.
- Base Value of Exchanged Cryptocurrency: If you swapped one cryptocurrency for another, the original ‘cost’ of the crypto given up is deductible.
- Advertising Expenses: Costs incurred while seeking a buyer or a seller.
- Valuation and Calculation Costs: Expenses related to valuing or partitioning your holdings to determine gains or losses, including software subscription fees specifically for this purpose.
- Professional Contracting Fees: Costs associated with preparing contracts for buying or selling the cryptocurrency.
However, expenses related to mining activities, such as equipment costs, cannot be claimed as deductions in this context.
How to claim crypto losses on your tax return in the UK
HMRC has laid out clear directives when it comes to managing capital losses. Notably, there is no ceiling to the number of capital losses that can be offset against gains.
This means that any significant capital loss can be used to decrease your gains down to the Capital Gains Tax (CGT) personal allowance level.
If you find yourself with losses that exceed your gains or if there are no gains to counterbalance, these losses can be carried over to subsequent financial years, serving as an offset against future gains.
However, to benefit from this carry-forward mechanism, these losses need to be duly registered.
Registration can be achieved either through the completion of a Self Assessment tax return or by providing HMRC with a formal written notification of the losses.
Continue reading: Where does crypto go in the HMRC tax return?
It’s essential to act within a stipulated time frame: you’re granted a four-year window from the time of the loss to register it with HMRC. Failure to do so will lead to the forfeiture of the privilege to carry them forward.
Another pivotal aspect that investors should remain vigilant about is the intricacies surrounding the same-day and 30-day CGT rules.
These guidelines are in place to prevent a tactic often referred to as ‘bed and breakfasting‘, where investors deliberately sell assets at a loss and quickly buy them back to obtain a tax advantage.
Common mistakes to avoid
When trying to offset crypto losses in the UK, there are some common pitfalls that investors can fall into. Here are several mistakes to be aware of:
- Incomplete Record-keeping: HMRC expects detailed records of all your transactions, including dates, amounts, and the involved parties. Failing to maintain comprehensive records can lead to incorrect calculations and potential disputes with HMRC. Use our free crypto portfolio tracker for automated transaction recording.
- Misunderstanding Disposal Events: In the context of cryptocurrency, disposals aren’t just sales. Exchanging one crypto for another, gifting, and even using crypto to purchase goods/services can all be considered disposals.
- Ignoring the ‘Bed and Breakfasting’ Rule: Selling a crypto asset and then re-buying it shortly afterwards (within 30 days) to realise a loss and reduce your tax liability is a strategy that HMRC is aware of. The same-day and 30-day rules prevent this kind of tax advantage play.
- Not Reporting Losses in Time: You have a four-year window to report your losses to HMRC. Missing this timeframe means you lose the ability to carry forward those losses to offset against future gains.
- Misapplying Negligible Value Claims: Claiming that a cryptocurrency has become worthless or of negligible value requires a proper understanding of the rules and, often, evidence that there is no chance of recovery.
- Miscalculating the Cost Basis: Using the wrong method or making mistakes when calculating the cost basis of crypto assets (i.e., what you originally paid for them plus associated costs) can lead to incorrect loss figures.
- Overlooking Fees and Allowable Costs: Transaction fees, costs associated with obtaining professional valuations, and other relevant expenses can be deducted. Failing to include these can lead to an overestimation of your gain or an underestimation of your loss.
- Assuming All Crypto Activities are the Same: Different activities, such as mining, staking, or earning interest on crypto holdings, might have different tax implications. Treating all these as straightforward disposals can lead to errors in your tax return.
- Not Reporting at All: Given the anonymous nature of some crypto transactions, some individuals mistakenly believe they don’t need to report them. HMRC has been enhancing its efforts to trace crypto transactions, and failing to report can lead to significant penalties.
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FAQ – Offsetting crypto losses
Can you write off crypto losses on taxes?
Yes, investors can write off crypto losses against their capital gains. This means that if an investor sells cryptocurrency at a loss, that loss can be used to offset any gains they’ve made, potentially reducing their tax liability.
Can you offset capital losses against income tax?
No, in the UK, investors cannot directly offset capital losses from cryptocurrency against their income tax. Instead, these losses are offset against any capital gains they might have. If there are no gains to offset, these losses can be carried forward to future tax years.
Can crypto losses be carried forward?
Yes, if investors have capital losses that exceed their gains, or they have no gains at all, they can carry forward these losses to subsequent fiscal years. However, to benefit from this, the losses must be duly registered with HMRC within a four-year window.
Can crypto losses be carried backward?
No, in the UK, investors cannot carry back crypto capital losses to offset against gains from previous years. They can only offset against gains in the same year or carry them forward to offset future gains.
Do you have to report crypto losses on your tax return?
Yes, investors are required to report all crypto transactions, including losses, to HMRC if they are used to offset crypto gains. This can be done either by completing a Self Assessment tax return or by formally notifying HMRC of the losses in writing.