Investing in cryptocurrency can be exciting, but when it comes to taxes, things can get complicated. Have you ever calculated your tax liability only to find that your capital gains are much higher than you expected compared to your overall profit or loss? Are you putting off accurately calculating your crypto taxes until your estimated profits get closer to the annual capital gains allowance?
In this blog, we break down the key differences between net profit and loss and taxable capital gains and losses. Learn why it’s essential to track your taxable gains throughout the year and how staying on top of your records can help you estimate and plan for your tax bill and optimise your tax position.
This guide is intended as a generic informative piece. This is not accounting or tax advice that can be relied upon for any UK individual’s specific circumstances. Please speak to a qualified tax advisor about your specific circumstances before acting upon any of the information in this article.
What is net profit and loss?
Your net profit and loss represents the overall gains or losses from your crypto activities. This includes the cumulative result of all your trades, sales, and purchases over a given period.
What is taxable gain and loss?
Taxable gain and loss is the total capital gain and loss as dictated by HMRC tax rules. HMRC guidance states that when you dispose of a crypto asset - by selling, trading, spending, or gifting it - you trigger a taxable event.
A capital gain is realised if the disposal proceeds (sale price) exceed the original acquisition cost. If your total capital gains exceed the annual exemption allowance in the tax year, you'll need to file a tax return.
Realised losses can offset capital gains in the same tax year or be rolled forwards to be used against future capital gains.
Calculating your capital gain isn’t always straightforward, as HMRC’s matching rules determine acquisition costs based on your entire holding of the asset across all wallets and accounts. Take a look at the 4 step process for calculating capital gains in our blog capital gains tax on cryptocurrency for more detail.
Why understanding the difference matters
Recognising the difference between net profit and taxable gain is critical for accurate tax reporting as the two concepts can create wildly different totals.
Whilst HMRC guidance is specific on how capital gains applies and should be calculated and reported, the way you estimate your crypto profit could vary. For example, are you considering the profit of your whole portfolio, or each account and wallet individually and what time period are you including?
Misunderstanding net profit and taxable gain can lead to:
- Filing incorrect tax returns.
- Unexpected tax bills or penalties from HMRC.
For instance:
- You might see a high net profit but, after applying tax rules like HMRC’s matching rules and allowable deductions, discover that your taxable profit is lower.
- Conversely, the more critical and often overlooked aspect is that you could have an overall net loss but still face a significant tax bill due to realised gains earlier in the year.
Important considerations
If you are only tracking net profit then you're probably estimating your gain based on what you first invested and what it's now worth and might be overlooking the following:
Realised vs. unrealised gains and losses
For tax purposes, a gain or loss is "realised" when you dispose of a crypto asset. Losses can offset gains but must be realised in the same tax year. Any unused losses can be carried forward to future tax years but not rolled backwards. If you’re estimating profit/loss, you might miss taxable gains realised earlier in the year and:
- Incorrectly assume you're currently at a loss overall so don’t need to file a tax return.
- Fail to realise losses within the same tax year, forfeiting the chance to offset gains.
Trading crypto to crypto
Each crypto-to-crypto trade is a taxable event. Frequent trading can result in substantial taxable gains, even without converting assets to fiat currency. This cumulative impact might leave you with a significant tax bill despite having little net profit, particularly with the market volatility of cryptoassets.
Spending and gifting crypto are also taxable disposals that might leave you exposed to taxable gains without realising or prior planning.
HMRC matching rules
Many investors "keep an eye" on their crypto profits for each exchange or wallet with the intention to calculate and file their crypto taxes when they get close to the capital gains allowance. Not only might this approach miss taxable transactions as covered above, it can also bypass HMRC matching and pooling rules used for cost basis, meaning the capital gain or loss could be massively underestimated or overestimated. Find out more about HMRC matching rules in our article about cost basis.
Timing of disposals
The UK tax year runs from April to April and the tax deadline is the following January. Proactively tracking your capital gains throughout the year, or even just checking in before the end of the tax year on 5th April can help you close the year in a better position. This prevents nasty surprises if you leave all calculations until it's time to file by which time it's too late as the tax year has already ended.
Examples of differences in crypto net profit/loss and taxable gain/loss
Let’s explore a couple of simple examples to emphasise the differences and potential for inaccurate tax filing or lack of...
Example 1: Buying and selling:
Kev buys 1 Bitcoin for £8,000 on Coinbase. A year later, he sells it for £10,000, thinking he’s made a £2,000 profit and is below the annual capital gains allowance (currently £3,000).
However, Kev also owns another Bitcoin bought in the early days for £100.
Under HMRC’s matching rules, all Bitcoin holdings are pooled:
- Total acquisition cost: (£8,000 + £100) = £8,100
- Average cost per Bitcoin: £8,100 / 2 = £4,050
Kev’s capital gain is:
- Disposal proceeds (£10,000) - Acquisition cost (£4,050) = Capital gain (£5,950)
This example shows it's important to include all history when calculating the capital gains on a disposal. Kev actually needs to file a tax return, as his gain exceeds the annual allowance.
Example 2: Trading crypto to crypto:
Kat trades 1 Ethereum for 10 Litecoin. While the Litecoin value might equal the Ethereum value at the time, this is a taxable disposal of Ethereum and acquisition of Litecoin.
- There is a taxable gain or loss on the Ethereum - the difference between Ethereum’s disposal proceeds (its fair market value when traded for Litecoin) and its acquisition cost (established using HMRC matching rules).
- The acquisition of Litecoin is not taxable, but it's fair market value must be recorded to be used to calculate future gains or losses if disposed of later.
This example highlights the importance of keeping records and planning ahead to ensure you can afford your tax bill. You might be making significant gains trading crypto to crypto without realising these transactions are taxable. Investors have been caught in tricky tax positions by realising high capital gains then falling victim to a market crash. If assets need to be sold to fiat in order to pay the tax bill, this also generates another taxable event.
Tips for keeping track of your crypto transactions
- Maintain detailed records: Record all transaction details, including dates, amounts, and associated costs.
- Stay informed: Keep up-to-date with HMRC’s guidelines to ensure accurate calculations.
- Use a crypto tax calculator: Tools like Recap automatically track your transactions and calculate taxable gains allowing you to keep track of your tax position throughout the year.
Conclusion: Using Recap to track profit and taxable gain
Understanding the difference between net profit/loss and taxable gain/loss is essential for managing your tax obligations and avoiding HMRC penalties. Using a crypto tax calculator simplifies the tax process by automating record-keeping, pricing valuations, and calculations.
Recap's dashboard provides a view of both. It shows your realised and unrealised gains and estimates your capital gains tax for each year. This helps you stay tax compliant, shows your investments’ performance and identifies tax saving opportunities. Get started with Recap for free today!
