Take Advantage of This Tax Loophole while it Lasts
Cryptocurrencies are free of wash sales rules, for now.
Disclaimer: Tax laws are in a constant state of change. This is not professional tax advice. The following is for discussion and entertainment only.
Are you sad that Christmas has passed? Well, I have a present for you…if you’re a cryptocurrency investor that is.
Actually, the word cryptocurrency is a bit of a misnomer; current tax laws in America treat cryptocurrencies as property, as opposed to currencies such as the U.S. dollar. For example, if you buy a coffee with Bitcoin, that transaction is subject to capital gains taxes if the value of the Bitcoin at the time of transacting is higher than you originally purchased it for.
This type of tax structure disincentivizes people from using cryptocurrencies like Bitcoin or Ethereum as money. Instead, cryptocurrencies are much better suited as instruments for saving, investing, or stores of value.
However, just as cryptocurrencies are not considered currencies, they are also not considered securities by the IRS. Since they are treated as property, losses on cryptocurrencies are treated very differently than those for stocks.
Tax Loss Harvesting with Cryptocurrencies
For example, if you sell a stock, mutual fund, or ETF at a loss, you cannot deduct those losses on your taxes unless you wait at least 31 days before repurchasing the same investment. This is referred to as the wash-sale rule. Furthermore, even if the stock or security you repurchase is not identical to the one you sold, it may be deemed “substantially identical” and therefore not apply.
Amazingly, these wash-sale rules do not apply to cryptocurrencies like Bitcoin or Ethereum. This means that crypto investors can their sell coins at a loss for tax purposes and then immediately buy them back.
Consider the following example. Let’s say you bought Bitcoin at $60,000 in November. Now, in December, Bitcoin is sitting at around $50,000. Let’s say you decide to sell your Bitcoin at a $10,000 loss and immediately buy it back at the same price ($50,000).
This $10,000 would count as a capital loss and would first go towards offsetting any capital gains you realized during this year. Any remainder, up to $3000, would go towards lowering your ordinary taxable income for the year. But wait! It gets even better. Any remaining balance (of the $10,000 loss) rolls forward to future years indefinitely to offset future capital gains or ordinary income until it is fully used up.
This is truly a Christmas miracle!
It is important to emphasize that if you wanted to stay fully invested in the same asset (Bitcoin in this example) you are free buy back immediately without the wash-sale rule applying (which we assumed in the example). Notice that — if you buy back at the same, or lower price — you have not lost any money on the investment, but have harvested a significant tax deduction. Just make sure to keep a good record of your cryptocurrency transactions.
Too Good to Be True?
You might be wondering, what’s the catch? There is none.
However, remember that cryptocurrencies can be extremely volatile at times. This means that even if you plan to sell and repurchase your crypto immediately, it is still possible for the asset to spike up instantly, causing you to miss your target repurchase price.
Additionally, many things that are too good to be true are often ephemeral. In this case, the U.S. government sees a major source of tax revenue that is currently not being harvested.
In fact, President Joe Biden’s Build Back Better Bill, which has encountered some obstacles recently, proposes changes that would make commodities, foreign currencies, and cryptocurrencies subject to wash-sale rules. As originally proposed in the House-passed version, the rule would take effect January 1, 2022. As it is written, the rule would not be retroactive. The Joint Committee on Taxation estimates such a change could raise $17 billion to help pay for the Bill’s proposed spending plan.
For now, cryptocurrency investors can take a breath of relief following Senator Joe Manchin’s (D-W.Va.) announcement that he opposes the Bill in its present form, effectively killing it. Therefore, investors interested in taking advantage of this lucrative tax loophole should be able to do so in 2021 without the risk of encountering wash-sales rules. This may also be the case for the foreseeable future in 2022.
Merry Christmas!