The HMRC has released solid guidance on how cryptocurrencies are taxed in the UK. It's all fairly straight forward, mining/staking income is same as income from any non-crypto source and profits/losses made from crypto trading are treated in the same way as profits from shares/stocks. However, things may seem complicated for crypto traders who have never declared capital gains taxes. In this article we will look at the HMRC's rules for declaring profits/losses for your crypto trades.
What is a capital gain and what's this cost-basis I keep hearing about?
A capital gain is the difference between the selling price and the buying price of an asset. The buying price and any associated costs is known as the cost-basis. Whenever you sell crypto you have to figure out the cost-basis for the sold assets so you can deduct your costs before paying tax.
If you are buying 10 BTC and later selling the entire 10 BTC then your cost-basis is easy to calculate but if you buy 10 BTC, sell 5 BTC, buy another 10 BTC and sell 5 BTC again, your cost-basis becomes more difficult to keep track of.
An easy way of keeping track of your cost is to simply take the average cost of all your holdings and multiplying that by the sold amount. This is known as Average Cost Basis and is the foundation for calculating your capital gains in the UK and many other countries.
How to calculate profit & loss on crypto trades with Share Pooling
The Average Cost Basis (ACB) can be easily manipulated to dodge taxes for ex. by selling all your holdings at a loss in order to reduce your taxes and rebuying them afterwards. To counter this the HMRC lays out rules that define how the average cost should be calculated.
- If you are buying and selling assets on the same day then the Average Cost is calculated by taking the average cost of holdings bought during that day. This is known as the same-day rule. If you are selling more than you bought on that day, use rule #2 for the remaining assets.
- The average cost of assets bought during 30 days following the day of disposal. This is known as the 30 day rule. If you did not buy enough assets in this period to cover all the disposed assets then move to rule #3 for the remaining amount.
- Take the average cost of all assets bought prior to the disposal (aka section 104 holdings).
These rules pose challenges for anyone trading with crypto as you could have hundreds, if not thousands, of transactions which is why Koinly has developed a sophisticated crypto tax calculator that can reliably calculate the cost-basis for each of your crypto transactions and generate your final capital gains. You can get started for free by signing up for Koinly.
Ryan carried out the following transactions for Bitcoin:
1 Jan 2019 – Purchased 4 BTC for £6,200
30 Aug 2019 – Purchased 2 BTC for £8,800
15 Dec 2019 – Sold 4.5 BTC for £27,000
15 Dec 2019 – Purchased 0.5 BTC for £2,500
Screenshot from the Koinly app showing cost-basis and gains for these transactions
In this example, the disposal is first matched with the purchase made on the same day, then against the share pool.
The main reason why you have to use the 30-day-rule is to prevent a practice known as bed and breakfasting where a person sells shares when they are trading at a low price to generate a tax loss and later buys the assets back to maintain his position in that asset. This is also known as a wash-sale as it is not a genuine sale. The 30-day-rule makes this much more difficult as the person will not be able to buy the assets back within 30 days if he wants to use the losses.
Douglas purchased 1,000 XRP on 5 July 2018 for £10,000. The price of XRP has fallen in value, so he would like to establish a capital loss. So, he sells the shares on 2 December 2018 for £2,000 and purchases them back on 10 December 2018 for £1,900.
Douglas’s transactions are caught by the 30-day rule. The disposal on 2 December 2018 will be matched with the purchase on 10 December 2018, and for 2018–19 he will therefore have a chargeable gain of £100 (2,000 – 1,900).
Hopefully you now have a better idea of how capital gains are calculated in the UK according to HMRC's share pooling rules. If you want to learn more, you can check out Koinly's free UK crypto tax guide which goes over the tax rules for different types of crypto transactions as well as ways of reducing your taxes.