Forex trading involves risk. Losses can exceed deposits

Crystallisation definition

Forex trading involves risk. Losses can exceed deposits

What is crystallisation?

Crystallisation means selling an asset in order to realize capital gains or losses. When an investor buys an asset, any increase or decrease in the market price will not automatically translate to profit or loss – this is only realized after the position has been closed.

Once the position has been crystallised, investment tax may be applicable to the proceeds, which is why investors might choose to strategically crystallise their positions. However, capital losses can be offset against any profits to reduce the tax paid at the end of the year.*

Crystallisation itself not an issue, but there is contention surrounding what the investor does after crystallising a position. The problem lies in the act of an investor, trader or a business, closing their position and opening an identical position immediately. In doing so, they are able to balance out the net value of their assets by quickly realising a loss or profit, without losing the position that they believe can still bring more profit.

However, most countries have tax regulations in place to prevent this practice from occurring.

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Example of crystallisation

Let’s say an investor has 100 shares of company ABC, which were bought for $50 each in 2017. By the following year, the share price has increased dramatically to $180 per share – the capital gains would be ($180-$50) x 100 = $13,000. The investor decides to crystallise the position, meaning it is closed and their profit is realised.

The profit on this ABC position could be subjected to tax, which would vary depending on the investor’s ordinary income tax rate. If the capital gains tax is 20%, this means the investor would pay a sum of $2600 and take a profit of $10,400.

However, at the same time as their position on ABC shares, the investor also has a position on 50 shares of company XYZ. Although they bought the shares for £80 per share in 2017, they have since declined to £20 each – the capital loss is ($20-$80) x 50 = -$3000. The investor decides to crystallise the capital loss on the investment, to offset the capital gains tax.

Instead of a gain of $13,000, the investor may choose to subtract their capital loss, to give a figure of $10,000. The capital gains tax on this profit would be reduced, with the investor only paying $2000.

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* Tax laws are subject to change and depend on individual circumstances. Tax law may differ in a jurisdiction other than the UK.

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