Cryptocurrency: when can you claim tax losses in a falling market?

Over the past year, the world has seen the prices of many cryptocurrencies fall sharply. This has resulted in investors, traders and businesses crystallising losses or having unrealised losses on their books.

From a tax perspective, the question is whether these losses are deductible.

What is crypto for tax purposes?

Crypto has been defined as:

a digital currency in which transactions are verified and records maintained by a decentralized system using cryptography, rather than by a centralized authority.

Relevantly for tax purposes, crypto is not a currency; however it is a CGT asset.

What is the correct tax treatment?

In tax world, there are three possible ways for crypto to be characterised. Crypto can be:

1. an investment asset – meaning that it is generally held on capital account and losses can only potentially apply to reduce future capital gains
2. an asset purchased as part of a profit-making scheme – meaning any loss will only be accounted for once the crypto has been disposed
3. an asset purchased as trading stock of a business – meaning that the trading stock provisions operate to determine when deductions for losses can be applied.

Case study

Bessie the sheepdog, operates a business through her company Bessie Pty Ltd. It creates and trades in Non-Fungible Tokens (NFTs). Bessie uses the crypto, DoggyCoin, to purchase NFTs and receives DoggyCoin when she sells her NFTs.

Bessie’s company usually has significant reserves of DoggyCoin that she uses to acquire NFTs and pay expenses in relation to the business. During the 2022 income year, DoggyCoin experienced a significant fall in price.

Bessie needs to work out how these unrealised losses are treated for income tax purposes. If the DoggyCoin is a capital asset or purchased as part of a profit-making scheme, any losses will only be available once the DoggyCoin has been sold and the losses are realised.

In this case however, provided that the company is operating a business trading NFTs, its DoggyCoin is likely to be trading stock. This is also the ATO view. The issue is likely to be whether Bessie Pty Ltd meets the threshold for carrying on a business.

What does this mean for Bessie Pty Ltd?

If DoggyCoin is trading stock, then Bessie’s company:

1. accounts for the cost of acquiring DoggyCoin as a deduction
2. accounts for the sale of any DoggyCoin as assessable income
3. must, at the end of each income year, determine the difference between the value of the trading stock at the beginning of the year and at the end of the year, and:.

• • if the value is higher at the end of the year, the difference will be assessable income
  • if the value is lower at the end of the year, the difference will be a deduction.

Importantly, Bessie can choose to value DoggyCoin at the end of the year at its market selling value. This may mean that Bessie’s company can access the company’s unrealised losses on the decrease in value of its DoggyCoin and claim this as a deduction.

Conclusion

Income tax loss rules can be complicated, particularly in the context of share trading and cryptocurrency.

If you would like to look in greater detail at issues relating to losses, click here to join us on 30 August 2022, for the third webinar in our 2022 tax masterclass series – The loss of losses – considering whether losses are on capital or revenue account and traps with the non-commercial loss rules.

If you would like assistance with checking the correct tax treatment of losses, please contact a member of our team.