How to manage crypto losses on tax returns in the US, UK and Canada

Cryptocurrency taxation is a subject of increasing importance, with governments worldwide working diligently to establish clear rules for taxing digital assets. In the United States, the United Kingdom, and Canada, crypto holders navigate complex regulatory landscapes, making it crucial to understand how crypto losses are taxed and their potential impact on tax liability. Whether new to crypto trading or with years of experience, reporting income and paying applicable taxes in compliance with local regulations is essential.

To comply with local cryptocurrency taxation laws, crypto holders must stay informed and compliant to avoid legal issues. This article examines the rules, deductions and implications an investor needs to know to stay compliant and minimize tax obligations in this ever-changing crypto tax landscape.

Taxation of crypto losses in the United States

U.S. approach to crypto taxation

In the U.S., the Internal Revenue Service (IRS) requires all sales of crypto to be reported, as it classifies cryptocurrencies as property and subject to capital gains tax. Gains and losses from crypto transactions are categorized by their duration, allowing losses to offset gains and reduce overall tax liabilities.

Unless generating staking-related interest or other exceptional cases, cryptocurrencies kept in a portfolio are typically not subject to IRS taxation. Furthermore, 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 essential for accurate capital gain or loss calculations. Moreover, reporting both losses and gains is mandatory, and the IRS is actively enforcing compliance with penalties for inaccuracies.

How are crypto losses taxed and offset in the U.S.?

In the U.S., crypto losses are typically categorized as capital losses, arising 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 surpass gains, the resulting net losses can be utilized for income tax deductions, allowing for a reduction of up to $3,000 from income, and 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 substantial tax savings, 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 U.S.

In the U.S., investors can engage in tax-loss harvesting with cryptocurrency, selling at a loss to reduce taxes due to the IRS’ property classification. Since the IRS treats cryptocurrencies as property rather than capital assets, it technically exempts crypto from wash-sale rules and allows more flexibility.

Crypto holders can utilize losses to offset gains without being bound by the wash-sale rule, enabling them to sell at a loss, realize tax benefits, and reinvest to maintain their position. Nevertheless, regulatory changes might extend the rule to crypto in the future, making safer strategies advisable to minimize capital gains.

Taxation of crypto losses in the United Kingdom

The U.K.’s approach to crypto taxation

In the U.K., claiming cryptocurrency losses on a tax return is an essential step in reducing overall tax liability. To initiate the process, it’s critical to keep thorough records of every crypto transaction.

His Majesty’s Revenue and Customs (HMRC) considers cryptocurrencies as taxable assets, meaning that trading or selling crypto can incur a tax liability. Since cryptocurrency is currently treated by HMRC similarly to the majority of other financial assets, it is subject to record-keeping requirements and Capital Gains Tax (CGT). The type of transaction determines the exact tax treatment.

In the U.K., the capital gains tax is a consideration for individuals trading in cryptocurrencies. The CGT rates are directly connected to the taxation of crypto losses and the utilization of tax-free thresholds. The current CGT rates range from 10% to 20%, depending on the individual’s income and gains.

How are crypto losses taxed and offset in the U.K.?

When reporting crypto losses, the CGT section of the Self Assessment tax return must be completed. This section enables the offset of capital losses against any capital gains incurred during the same tax year.

In the U.K., investors are not permitted 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 surpass gains, the remaining losses can be carried forward to offset future gains. This mechanism serves as a valuable tool for managing tax liability, particularly in the volatile cryptocurrency market, which has the potential for significant losses as well as gains.

Importantly, there is no immediate requirement to report crypto losses. However, if you 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.

Overall, by accurately recording and reporting crypto losses, individuals can fully leverage the tax relief provided by the U.K. government while effectively managing cryptocurrency tax obligations. The ability to carry them forward will be lost if this step is neglected.

Optimizing crypto tax reporting in the UK through token pooling

It’s worth noting that HMRC requires taxpayers to pool their tokens for calculating cost bases in cryptocurrency transaction gain/loss reporting. Tokens must be categorized into pools, each with an associated pooled cost. Upon 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 

Canadian approach to crypto taxation

The Canada Revenue Agency (CRA) considers cryptocurrency a 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. Therefore, 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 mandated to report transactions over $10,000. Even sub-threshold transactions may require customer data disclosure upon the CRA’s request.

How are crypto losses taxed and offset in Canada?

In Canada, investors need to report capital losses to the CRA to potentially reduce their tax liability, as the agency mandates filing an income tax and benefit return for any capital property sale, irrespective of a gain or loss outcome.

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, and 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 purchase; unrealized losses cannot be claimed on a tax return.

Superficial loss rule and treatment of crypto losses in Canada

Canada’s superficial loss rule, similar to the U.S. wash sale rule, prevents investors from exploiting artificial losses by selling and immediately repurchasing the same property within specific timeframes, ensuring a fair tax system.

According to the CRA, this rule comes into play to prevent wash sales if two conditions are met:

• The taxpayer or their representative obtains an identical cryptocurrency within 30 days before or after selling it.
• 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.