The importance of cryptocurrency taxation is increasing as governments worldwide work to establish clear rules for taxing digital assets. In the United States, the United Kingdom, and Canada, crypto holders face complex regulatory landscapes, making it crucial to understand how crypto losses are taxed and how they can impact tax liability. Whether you’re new to crypto trading or have years of experience, it’s essential to report income and pay applicable taxes in compliance with local regulations.
To stay compliant with local cryptocurrency taxation laws, crypto holders must stay informed and ensure they are following the rules to avoid legal issues. This article will examine the rules, deductions, and implications that investors need to know to stay compliant and minimize tax obligations in the ever-changing crypto tax landscape.
Taxation of Crypto Losses in the United States
In the United States, the Internal Revenue Service (IRS) requires the reporting of all crypto sales, as cryptocurrencies are classified as property and subject to capital gains tax. Gains and losses from crypto transactions are categorized based on their duration, allowing losses to offset gains and reduce overall tax liabilities.
Unless generating staking-related interest or in other exceptional cases, cryptocurrencies held in a portfolio are typically not subject to IRS taxation. Additionally, a loss cannot be declared if an individual has invested in a cryptocurrency that has completely lost its value and is no longer traded on exchanges.
Maintaining precise transaction records is crucial for accurately calculating capital gains or losses. Reporting both losses and gains is mandatory, and the IRS actively enforces compliance with penalties for inaccuracies.
How Crypto Losses are Taxed and Offset in the United States
In the United States, crypto losses are generally categorized as capital losses, which occur when the value of cryptocurrency holdings decreases from acquisition to the point of sale, exchange, or use. Reporting crypto losses can reduce taxes in two ways: through income tax deductions and by offsetting capital gains.
When losses exceed gains, the resulting net losses can be used for income tax deductions, allowing for a reduction of up to $3,000 from income. Any remaining excess losses can be carried forward to offset future capital gains and $3,000 of other income in subsequent years.
Cryptocurrency losses offer significant tax savings by offsetting capital gains without restrictions on the amount, potentially avoiding a substantial tax liability. The IRS categorizes losses as short-term or long-term, following the traditional investment framework. Short-term losses from assets held for under a year are taxed at ordinary rates (10%–37%), while long-term losses from assets held over a year face lower capital gains tax rates (0%–20%).
Wash-Sale Rule and Treatment of Crypto Losses in the United States
In the United States, investors can engage in tax-loss harvesting with cryptocurrency, selling at a loss to reduce taxes due to the IRS’ classification of cryptocurrency as property. Since cryptocurrencies are treated as property rather than capital assets, they are technically exempt from wash-sale rules, providing more flexibility.
Crypto holders can use losses to offset gains without being bound by the wash-sale rule, allowing them to sell at a loss, realize tax benefits, and reinvest to maintain their position. However, regulatory changes may extend the rule to crypto in the future, making it advisable to use safer strategies to minimize capital gains.
Taxation of Crypto Losses in the United Kingdom
In the United Kingdom, claiming cryptocurrency losses on a tax return is a crucial step in reducing overall tax liability. To initiate the process, it’s essential to keep thorough records of every crypto transaction.
The United Kingdom’s tax authority, His Majesty’s Revenue and Customs (HMRC), considers cryptocurrencies as taxable assets. This means that trading or selling crypto can incur a tax liability. Since cryptocurrency is currently treated similarly to other financial assets, it is subject to record-keeping requirements and Capital Gains Tax (CGT). The exact tax treatment depends on the type of transaction.
In the United Kingdom, capital gains tax is a consideration for individuals trading in cryptocurrencies. The CGT rates range from 10% to 20%, depending on the individual’s income and gains.
How Crypto Losses are Taxed and Offset in the United Kingdom
When reporting crypto losses, the CGT section of the Self Assessment tax return must be completed. This section allows for the offset of capital losses against any capital gains incurred during the same tax year.
In the United Kingdom, investors are not allowed to directly offset capital losses from cryptocurrency against their income tax liability. However, when losses arise from cryptocurrency transactions, they can be deducted from the overall capital gains in the tax year.
If total losses exceed gains, the remaining losses can be carried forward to offset future gains. This mechanism is a valuable tool for managing tax liability, especially in the volatile cryptocurrency market, which can experience significant losses and gains.
Importantly, there is no immediate requirement to report crypto losses. However, if you choose to claim them, there is a four-year window from the end of the tax year in which the losses occurred. This flexibility allows taxpayers sufficient time for financial assessment and loss claims aligned with individual tax planning.
By accurately recording and reporting crypto losses, individuals in the United Kingdom can fully leverage the tax relief provided by the government while effectively managing their cryptocurrency tax obligations. Neglecting to take this step may result in the loss of the ability to carry losses forward.
Optimizing Crypto Tax Reporting in the United Kingdom through Token Pooling
It’s important to note that HMRC requires taxpayers to pool their tokens when calculating cost bases for cryptocurrency transaction gain/loss reporting. Tokens must be categorized into pools, each with an associated pooled cost. When selling tokens from a pool, a portion of the pooled cost (along with allowable expenses) can be deducted to reduce the gain.
The pooled cost should be recalculated with each token purchase or sale. When tokens are acquired, the purchase amount is added to the relevant pool, and when they’re sold, a proportionate sum is deducted from the pooled cost.
Taxation of Crypto Losses in Canada
In Canada, the Canada Revenue Agency (CRA) considers cryptocurrency as property and subject to taxation as a commodity, falling under the categories of business income or capital gains. Disposing of crypto, such as selling it, trading it for another crypto, or using it for purchases, triggers capital gains tax.
In Canada, taxes are not imposed on purchasing or holding cryptocurrency as it’s not regarded as legal tender. However, using it for payments is seen as a barter transaction with corresponding tax consequences, resulting in potential capital gains or losses based on the cryptocurrency’s value change when exchanged for goods or services.
While crypto provides some anonymity, the Canadian government has the capability to trace crypto transactions as exchanges are required to report transactions over $10,000. Even sub-threshold transactions may require customer data disclosure upon the CRA’s request.
How Crypto Losses are Taxed and Offset in Canada
In Canada, investors must report capital losses to the CRA to potentially reduce their tax liability, as the agency requires the filing of an income tax and benefit return for any capital property sale, regardless of the outcome of gain or loss.
Canadian crypto taxpayers can offset various capital gains with cryptocurrency losses, carrying the net loss forward or using it to offset gains from the previous three years. However, cryptocurrency losses cannot be used to offset regular income within the year. 50% of cryptocurrency losses can be applied to offset capital gains in subsequent years or carry them back to previous years, mirroring the tax treatment of cryptocurrency capital gains.
Usually, when an allowable capital loss occurs within a tax year, it should be initially offset against any taxable capital gains within the same year. If there’s still an unutilized loss, it contributes to the net capital loss calculation for that year, which can then be applied to reduce taxable capital gains in any of the preceding three years or any future year.
It’s important to highlight that to access tax benefits, investors must “realize” their loss by selling cryptocurrency, exchanging it for another, or using it for a purchase. Unrealized losses cannot be claimed on a tax return.
Superficial Loss Rule and Treatment of Crypto Losses in Canada
Canada has a superficial loss rule, similar to the U.S. wash-sale rule, to prevent investors from exploiting artificial losses by selling and immediately repurchasing the same property within specific timeframes. The rule ensures a fair tax system.
According to the CRA, this rule applies to prevent wash sales if two conditions are met:
1. The taxpayer or their representative obtains an identical cryptocurrency within 30 days before or after selling it.
2. By the end of this period, the taxpayer or an affiliated person holds or has the right to acquire the same cryptocurrency.
These losses cannot offset capital gains but are instead added to the adjusted cost base of the repurchased property.