Crypto Losses: How to Claim Tax Relief

Introduction

Crypto losses: realised losses vs. unrealised losses

Realized and unrealized losses are financial concepts that highlight the difference between an asset’s purchase price and its current market value.

A realized loss occurs when you sell your cryptocurrencies for a price lower than your initial purchase. This loss is considered “realized” because, through the sale, you have officially incurred the loss, whether you converted the cryptocurrency into fiat currency or another digital asset.

In contrast, an unrealized loss is hypothetical. It occurs when the market value of your cryptocurrency drops below the purchase price, but you have not yet sold it. This “paper loss” remains on your portfolio until you either sell the asset or its value recovers.

Claiming realised losses on trading activity

In the UK, if you’ve sold cryptocurrency at a price lower than what you bought it for, you have the opportunity to report this as a realized loss on your tax return. This loss can be used to offset other capital gains, potentially lowering your overall tax obligation for the year. It’s essential to maintain accurate records of all your transactions to calculate your cost basis correctly.

Claiming losses on lost or stolen crypto

HMRC does not consider lost or stolen cryptocurrencies as capital losses because you are still considered the rightful owner, and there hasn’t been an actual sale or disposal. However, there is a provision for making a negligible value claim if you can provide evidence of permanent loss of access.

 

Claiming losses on frozen funds

There have been instances of bankruptcy involving major cryptocurrency service providers, such as FTX, which have left numerous investors with frozen assets.

Regrettably, there are limited options available to these affected investors.

HMRC usually does not permit immediate claims because there is a slight possibility of recovering these assets.

Investors are advised to await the outcome of bankruptcy proceedings. If no funds are returned after this process, a negligible value claim might become an option, allowing them to offset potential future gains.

Claiming losses on rug pulls

Rug pulls, where developers abandon a project and take investors’ funds, create a unique situation when it comes to capital losses.

In the aftermath of such events, investors often still hold their tokens. This means it’s not automatically recognized as a capital loss, even though the tokens have lost their value and utility.

To realize a loss that can be reported on your crypto tax return and offset against gains, investors must dispose of these tokens. Here are several methods to consider:

Selling on Exchanges: If your tokens are still listed, the simplest approach is to sell them on a cryptocurrency exchange.

Swapping Tokens: For tokens that have been delisted, you may be able to swap them for a different cryptocurrency using a native or non-custodial wallet.

Gifting Tokens: You can gift the tokens to someone other than your spouse (as gifting to a spouse isn’t a taxable event) to realize the loss.

Burning the Tokens: If none of the above options are feasible, sending the tokens to a burn wallet, effectively destroying them, can create a capital loss.

In the rare event that an entire blockchain is halted following a rug pull, a negligible value claim might be the most appropriate course of action.

Claiming losses on worthless NFTs

NFTs, or Non-Fungible Tokens, have become widely popular as unique digital assets representing various forms of value, including art and collectibles. However, like any other assets, the value of NFTs can fluctuate, and some may eventually become worthless.

For tax purposes, simply owning a worthless NFT isn’t enough to claim a capital loss. To realize and claim the loss, you must dispose of the NFT. Here are steps you can take:

Selling the NFT: Even if the NFT’s value has drastically declined, you can try to sell it on a marketplace for a minimal price. This sale, even at a significant loss, will help you realize the capital loss.

Gifting the NFT: Similar to other crypto tokens, you can gift the NFT to someone other than your spouse. This allows you to dispose of the asset and realize the loss.

Burning the NFT: Some NFT platforms offer the option to ‘burn’ or permanently delete the NFT. By burning it, you’re essentially confirming the NFT’s worthlessness and disposing of it, which can help in realizing the capital loss.

What costs can be claimed?

When calculating cryptocurrency losses, certain expenditures are eligible for deductions:

Initial Investment: This includes the fiat currency amount used for the initial cryptocurrency purchase.

Pre-Blockchain Transaction Fees: These are the costs incurred before the transaction is recorded on a blockchain.

Base Value of Exchanged Cryptocurrency: If you exchanged one cryptocurrency for another, you can deduct the original ‘cost’ of the crypto you gave up.

Advertising Expenses: Any expenses incurred while actively seeking a buyer or seller.

Valuation and Calculation Costs: This covers expenses related to valuing or dividing your holdings to determine gains or losses, including software subscription fees designed for this purpose.

Professional Contracting Fees: Costs associated with the preparation of contracts for cryptocurrency buying or selling.

It’s important to note that 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 provided clear guidelines for managing capital losses. Notably, there is no limit to the number of capital losses that can offset gains.

This means that significant capital losses can reduce your gains to the level of the Capital Gains Tax (CGT) personal allowance.

If your losses exceed your gains or there are no gains to offset, these losses can be carried forward to future financial years to offset against future gains.

However, it’s crucial to register these losses to benefit from the carry-forward mechanism. You can register them through a Self Assessment tax return or by formally notifying HMRC in writing.

Timing is essential: you have a four-year window from the time of the loss to register it with HMRC. Failure to do so will result in the loss of this privilege.

Investors should also be aware of the intricacies of the same-day and 30-day CGT rules. These rules are designed to prevent “bed and breakfasting,” where investors intentionally sell assets at a loss and quickly repurchase them to gain a tax advantage.

Common mistakes to avoid

When trying to offset crypto losses in the UK, investors should be aware of common pitfalls. Here are some mistakes to avoid:

Incomplete Record-keeping: HMRC requires detailed records of all transactions, including dates, amounts, and parties involved. Poor record-keeping can lead to calculation errors and disputes with HMRC. Consider using a crypto portfolio tracker for automated transaction recording.

Misunderstanding Disposal Events: Disposals in cryptocurrency go beyond sales. Exchanging one crypto for another, gifting, or using crypto to buy goods/services can all be considered disposals.

Ignoring the ‘Bed and Breakfasting’ Rule: Selling a crypto asset and repurchasing it within 30 days to realize a loss and reduce tax liability is a strategy HMRC monitors. Same-day and 30-day rules prevent this tax advantage.

Not Reporting Losses in Time: You have four years to report losses to HMRC. Missing this window means forfeiting the ability to offset future gains with those losses.

Misapplying Negligible Value Claims: Claiming a cryptocurrency is worthless or of negligible value requires a proper understanding of the rules and often evidence of no recovery possibility.

Miscalculating the Cost Basis: Incorrectly calculating the cost basis of crypto assets (original purchase cost plus associated expenses) can lead to inaccurate loss figures.

Overlooking Fees and Allowable Costs: Transaction fees, professional valuation costs, and other relevant expenses can be deducted. Omitting these can lead to overestimating gains or underestimating losses.

Assuming All Crypto Activities are the Same: Different activities like mining, staking, or earning interest on crypto holdings may have distinct tax implications. Treating them all as straightforward disposals can result in tax return errors.

Not Reporting at All: Some individuals mistakenly believe they don’t need to report crypto transactions due to their anonymous nature. HMRC has improved efforts to trace crypto transactions, and failure to report can lead to significant penalties.

 

Conclusion

For UK crypto earners, comprehending tax obligations is essential to avoid penalties and legal complications. It’s wise to seek professional crypto tax advice for compliance and informed financial decisions in the crypto realm. Fortunately, you’re on the right path.

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