Banking crypto investment losses with tax authorities

With the price of crypto assets falling this year amidst the backdrop of the war in Ukraine and interest rate hikes, many investors in the digital asset market will now be sitting on significant losses. Those hardest hit will be the ones that entered the markets in late 2021 at the height of the bull run and now find themselves underwater. Once a bear market sets in, it is inevitable that some cryptocurrency projects will not survive, leaving new investors licking their wounds. Some will panic sell at a loss, whilst others will hold until there is virtually no value remaining.

According to a survey in the US, 43% of males in the 18 to 29 age group have had some exposure to cryptocurrency investing. In the UK, the numbers are likely to be weighted more towards the younger generation. Whilst they may be astute when it comes to investing in this new asset class, many will have limited experience of tax rules, having never been required to complete a Tax Return, let alone make a loss relief claim.

Many of the discussions centre around gains in crypto but what can an investor do if they have made a loss?

Firstly, the acquisition and disposal of crypto assets is generally subject to the capital gains tax rules here in the UK, unless the trading volume is so significant that it warrants being a trade. The difference in tax rates are considerable with capital gains taxed at up to 20% and trading profits at up to 45% with national insurance on top.

Where a crypto investor has sold a cryptoasset at a loss, that loss must be claimed within four years of the end of the tax year in which the loss was realised. For example, if an individual sold 3 Ethereum at a loss on 15 February 2022, they would have until 5 April 2026 to make a claim for the loss relief. If that individual does not complete a UK Self-Assessment Tax Return (which many 18-29 years will not), they would need to write to HMRC within that time frame.

There are so many projects that fail to do the 100x that so many new investors dream of. Social media is awash with excited young investors who have ploughed thousands into projects promising the world only to find that after months or years, their investments are worth next to nothing. Most will retain those holdings in the hope that one day it may recover or it may be that the costs of disposing of the asset would cost more than the asset is worth. It may be the case that there is no liquidity left on the decentralised exchanges to enable them to sell the asset.

Very few will be aware of the ability to make a loss claim in these circumstances.

A ‘negligible value claim’ can be made where the value of an asset (including crypto assets as per HMRC’s Cryptoasset manual at CRYPTO22500) is worth next to nothing. There is no definition in legislation of ‘next to nothing’ so there is an element of subjectivity in assessing whether an asset is indeed worthless.

By way of an example. Mr Smith buys 10,000 tokens on a Decentralised Exchange for £0.50 per token in October 2021. By 5 April 2022 (end of the UK tax year), the price is £0.01 per token and it appears as though there is little liquidity remaining on the exchange and the founders have all but ceased social media interaction with the community. A claim could be made on a 2021/22 Tax Return to bank the £4,900 loss, which can then be carried forward indefinitely. The tokens are deemed to have been sold and reacquired at £0.01, despite the investor continuing to hold them. If the tokens are subsequently sold at a profit further down the line, Mr Smith would have to assess the gain to capital gains tax with the base cost now being £0.01.

If Mr Smith sells a buy to let property in 2022/23 realising a gain of £17,200, the £4,900 loss brought forward would cover the taxable element over and above the capital gains tax annual exempt amount, which currently stands at £12,300. This is worth up to £1,372 in tax relief as a higher rate taxpayer pays 28% on residential property gains.

If crypto investors do make gains in the future, whether this be on the sale of more digital assets or other assets subject to capital gains tax, they may live to regret not banking their crypto losses now. With the EU voting to ban anonymous cryptoasset transactions and the FATF rules for Crypto Exchanges and Custodians looking to tighten the rules up around money laundering, it will become easier for tax authorities to pick up gains. Failure to act now in banking losses to set against future gains could be costly.

For more information about the topic explored in this article, contact Paul Webster our Private client tax director or contact us here.