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The basics of cryptocurrency – what is it and how is it taxed?

Alex Straight from our US/UK Private Client team examines the different types of Cryptocurrency and how they are treated for tax purposes.

What are the different types of cryptocurrencies?

Bitcoin, Litecoin, Ethereum, Ripple and many others are all types of cryptocurrencies. They are becoming easier to purchase, with cryptocurrency exchange platforms gaining mainstream recognition. For many people, this has made buying and selling cryptocurrency easy. Various online banking platforms now give you the option to purchase and spend cryptocurrencies alongside your traditional currency accounts.

However, when it comes to taxation, cryptocurrency is different from traditional currencies. Cryptocurrencies are considered to be intangible assets, in the same way that stocks in companies are.

How is cryptocurrency taxed?

For tax purposes cryptocurrencies such as Bitcoins are taxed in almost the same way as a stock where you buy at one price, sell at another and have a gain or loss on the disposal

For tax purposes, this really is not a currency at all. These are assets which are being traded and exchanged for other assets. This results in interesting consequences with respect to the day-to-day usage of Bitcoins and the actual realities of the tax implications of these trades.

Imagine that, when paying for a cup of coffee, instead of paying $3 in regular currency you offer a stock worth $3.  For tax purposes you have a gain or loss on the disposal of that stock Now imagine that instead of stock these are Bitcoins. The same logic applies and this is where the terminology of cryptocurrencies is misleading.

Imagine that, when paying for a cup of coffee, instead of paying $3 in regular currency you offer a stock worth $3.

What does this mean for US and UK tax purposes?

For both US tax and UK tax purposes you could have multiple short-term capital gain or loss transactions. Although most retailers do not accept cryptocurrency for payment, when you convert your cryptocurrency holdings into pounds to then pay for your coffee, you have a taxable capital disposal. This is the opposite to our general idea of a currency being something which is freely transferred in return for goods and services. The ease at which apps allow you to hold and spend cryptocurrency means this is often isn’t considered.

The fact that cryptocurrency can be so easily bought through online platforms makes these far more accessible than buying stocks, which need to go through regulated brokers and requires the provision of tax reports. This means there is currently no tax reporting being provided to owners of cryptocurrencies in the same way that you may have a Form 1099 or end of year tax summary of your capital gains and losses of the various transactions you made. This means it needs to be tracked and worked out manually by taxpayers.

For US/UK taxpayers, like traditional investments, it involves considering both US and UK rules for capital gains. In the UK there is pooling of asset base costs, with same day and 30-day rules. In the US, you need to identify the item being sold or use a ‘first-in, first-out’ approach, which becomes important when considering if the item is subject to long-term or short-term capital gains rates. Of course for cryptocurrencies there can be unique challenges, such as the incredible volatility of the price during any given day, timing of the taxing events and where the US and UK consider the gain to be sourced for the purpose of foreign tax credits.

All this has attracted the attention of the tax authorities, particularly as the value of cryptocurrencies have increased and the suspicion that fraudulent activity is occurring using cryptocurrencies. The Internal Revenue Service (IRS) have been targeting cryptocurrency holders to disclose information about their transactions and have included questions related to cryptocurrency on tax returns for a couple of years now. Furthermore, the substantial value being created by people who own and create cryptocurrency has caught the attention of both HM Revenue & Customs and the IRS.

Final thoughts

Until the tax rules recognise cryptocurrencies in the same way as traditional currencies, this will be a significant barrier to their adoption and use as a new form of currency which benefits from the advantages of using distributive ledger technology. This will likely require some regulation and cooperation from the cryptocurrency exchanges and ‘wallets’ (which hold proof of your digital currency) to achieve. However, the more cryptocurrency transactions that occur, the more they will begin to look like traditional currency, and the tax rules may be challenged or changed to reflect this.

Would you like to know more?

If you have any questions on, or are unsure of the tax treatment of, cryptocurrencies, or would like to discuss your specific circumstances, please get in touch with your usual Blick Rothenberg contact or Alex Straight, using the form below.

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