Crypto winners cannot dodge the tax authorities

If anyone tells you crypto doesn’t matter to the average investor, think again. As many as one in three of my clients now holds crypto assets such as bitcoin. And the Financial Conduct Authority has put the overall number of crypto holders in the UK at no fewer than 2.3m.

Most of my clients have a stake worth just a few hundred pounds. But I do have at least one crypto millionaire — or at least he was a few weeks ago. These so-called currencies are so volatile that his holdings may have halved in value since we last spoke. Between mid-April and mid-July last year bitcoin fell by 50 per cent before doubling in the subsequent three months.

In the past, I would ask clients in our first meeting what savings and investments they own. I now have to ask specifically about cryptocurrencies. This is because most people do not seem to see them as investments. So what are they?

This question is important, not least because it governs how they are treated in relation to tax. There is a common perception that the profits of dabbling in crypto assets are not taxable. This is not the case. HM Revenue & Customs has a whole manual on the subject.

Some people try to argue that when you buy crypto assets in the hope that they will appreciate you are merely gambling and that gambling winnings are free of tax. I would not dispute that investing in cryptocurrencies is a gamble and you risk losing everything, but HMRC imposes special levies on the gambling industry that do not apply to these assets.

This means HMRC wants its share of the proceeds — in one way or another. If you are working and paid in cryptocurrency then it is taxed as income. If you sell, swap or spend crypto assets then any profits are taxed as a capital gain.

Last year Tesla, the carmaker, announced plans — briefly enacted before being reversed — to allow buyers to pay with bitcoin. I met one man who suggested that if he bought a Tesla with his crypto profits his money would not be converted into sterling, would not trigger a taxable event and would not be of interest to HMRC. I said: “But it will have been converted to a Tesla, and that will interest them — very much.”

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Even if you exchange your tokens for a different type of crypto asset, you will still be liable for tax on any profits.

Others recognise the tax implications of cashing in their crypto assets but assume that HMRC will not know about them and so believe they will not be caught if they do not declare their gains. This is not true either.

HMRC works with large crypto exchanges, requiring them to share customer information. It is now using that data to send out “nudge” letters, reminding investors of their responsibilities and liabilities.

There are ways to mitigate the impact of having had a successful run investing in crypto assets.

We each have a tax-free allowance of £12,300. If you bank profits under that limit — and remember to take into account realised gains on other assets held outside a pension or Isa wrapper — you will not be liable for capital gains tax (CGT). If you breach that limit you must pay.

You can give assets to your spouse or civil partner without triggering a CGT event. This can be a good way of effectively doubling your allowance. If you are a higher-rate taxpayer and your partner is a basic-rate taxpayer, then splitting the assets first is particularly sensible when a CGT bill is likely to arise from their disposal.

You would pay 20 per cent on any gains above the tax-free limit. If your partner’s taxable gains, added to any taxable income for the year, do not take them beyond the basic-rate limit — £50,270 — they will pay just 10 per cent.

We are coming to the end of the tax year. You could liquidate the assets on either side of April 6 to take advantage of two years’ worth of allowance in a short period.

Losing your private key and being unable to recover your crypto assets does not count as a loss in the eyes of HMRC

If you are feeling generous you can also donate a crypto asset to charity. You must not cash it in first. You will have to transfer ownership to the charity, which might be easier said than done.

Something else worth knowing is that you can offset realised losses against your gains. It is important to keep a note of these during the year, especially if you are trading regularly. There is no limit on the amount or number of losses you can offset. You can even carry forward any unused capital losses into the following three years if they extend beyond your gains.

Losing your private key and being unable to recover your crypto assets does not count as a loss in the eyes of HMRC, though I appreciate it must feel like one to anyone unfortunate enough to be in this position.

As a final aside, it is worth remembering that crypto assets will be property for the purposes of inheritance tax (IHT) and this will need to be factored into any IHT planning.

It is hard to understand crypto assets. It is pretty hard to understand the UK tax system, too. But if you are going to invest in the first then you need to get your head around the second. Failure to do so could leave you with a very painful bill from HMRC — perhaps when you have already spent your winnings.

Rebecca Aldridge is a chartered financial planner and founder of Balance Wealth Planning