HMRC has released solid guidance on how cryptocurrencies are taxed in the UK, sending the clear message to crypto investors that they need to calculate and report their crypto taxes.
Fortunately, UK crypto tax is all fairly straight forward. Mining and staking is seen as ordinary income - like from a non-crypto source - and subject to Income Tax. While profits or losses made from crypto trading are treated in the same way as shares or stocks and subject to Capital Gains Tax.
However, things may seem complicated for crypto traders who have never declared Capital Gains Taxes - in particular, the stringent rules around using the UK share pooling cost basis method. In this article we will look at the HMRC's rules for declaring profits and losses from your crypto trades and how to calculate crypto tax.
What is a capital gain or loss?
A capital gain or loss is the difference between price you bought an asset for and the price of the asset when you sold, swapped, spent or gifted it. 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.
Simple, right? Well... not quite.
What is a cost basis method?
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. Which asset did you sell and when? Did you make a profit or a loss?
For example... let's say you bought 1 BTC for £7,000 in December 2019. In January 2021, you bought another BTC for £35,000. Last month, you sold 1 BTC for £31,000. If you use your first BTC purchased as your cost basis - you made a capital gain of £28,000. If you use your second BTC purchased as your cost basis - you made a capital loss of £4,000.
Obviously, this has huge implications for your tax bill. In one instance you're paying tax on £28,000 and in another you have a capital loss of £4,000 to offset against any other gains.
This is where a cost basis method comes in. These are the rules countries set to give crypto investors guidance on how to calculate their cost basis and subsequent crypto taxes. HMRC has clear guidance on which cost basis method to use. It's similar to the Average Cost Basis method (ACB). ACB says you split your different coins/assets/tokens into pools, for example ETH, BTC and Doge. Then you create an average cost basis for each of those pools. To do this simply take the average cost of all your holdings and divide that by the amount of coins/tokens held in the pool.
HMRC call it Share Pooling. It's similar, but they have a couple of specific rules to stop investors deliberately reducing their tax bill.
How calculate crypto taxes with the Share Pooling Cost Basis Method
Like we hinted at above, ACB is easily manipulated. Investors can sell all their holdings at a loss to reduce taxes and buy them back shortly after. To stop UK investors from doing this - the HMRC has laid out very specific cost basis rules that define how you calculate the average cost of assets.
You need to work through these three rules in order, as they apply to your assets.
1. Same Day Rule
If you buy and sell coins on the same day, use the cost basis on this day to calculate your gains or losses. If you've sold or traded more than you bought on that day, move on to rule 2.
2. Bed and Breakfasting Rule
If you buy and sell/trade coins within 30 days, use the cost basis of the coins bought this month to calculate your gains or losses. If you're selling more than you bought within the last 30 days, move onto rule 3.
3. Section 104 Rule
Use the average cost basis method to calculate an average cost for a given pool of assets. Add up the total amount paid for a pool of assets and divide it by the total amount of coins/tokens in the pool. Then use this cost basis to calculate subsequent gains or losses.
Let's look at some examples to better understand how each rule works.
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
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).
It's not just sales of crypto that are subject to the Same Day and Bed and Breakfasting Rule. Any disposal of crypto is subject to the Same Day and Bed and Breakfasting Rules - this includes crypto to crypto trades, spending crypto and gifting crypto.
Calculate UK crypto taxes with Koinly
Of course, for crypto investors trading large volumes - these rules pose challenges. You could have hundreds - if not thousands - of transactions. This is why Koinly has developed a sophisticated crypto tax software tool that can reliably calculate the cost basis for each of your crypto transactions and generate your final capital gains.
Koinly supports the share pooling cost basis method for UK investors. You can find this in settings.
This means Koinly can do all the calculations for you. All you need to do is head into your tax reports page and download the tax reports you need. Koinly can generate UK specific tax forms like the HMRC Capital Gains Summary.
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 UK crypto tax guide which goes over the tax rules for different types of crypto transactions as well as ways of reducing your taxes.