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The Crypto Tax Loophole

Quickly shedding light on the current lack of 'wash sale' rules regarding crypto.

26 Jan

I want to preface this article with the fact that I’m in no way, shape, or form offering tax advice. I’m not a CPA. I have zero formal accounting experience. I’m just a guy on the internet.

My CPA is actually this dude, and he’s the man.

As short and sweet as possible, I want to bring attention to something that I’ve been asked about dozens of times over the last few weeks — the crypto tax loophole.

As you may have read in yesterday’s post (below), I think it’s more than fair to say that we are currently in a bear market.

Will this be 3 months? 6 months? Longer? 

I don’t know, but I’m inclined to think that the second half of the year will be much better than the first, especially for cryptocurrency. Regardless of if it remains bearish over the coming months, volatility is a guarantee due to Fed interest rate worries, geopolitics, the supply chain, and COVID policies.

What comes along with bear markets? The fact that you have probably lost a lot of value in some (or a majority) of your positions. The good news is that crypto investors are able to take advantage of these losses and, as my friend Vanader loves to say, “be good to future you!”

Tax-Loss Harvesting

As most of you likely know, “tax-loss harvesting” is the selling of securities (stocks) at a loss to offset your capital gains tax liability. This strategy is typically used at the end of the year (because it’s the end of the tax period), but can be done at any time of the year.

Many of you use robo-advisors for your Roth IRA investing. Betterment, for example, has algorithms set up that may automatically lessen your positions in one holding and increase them in another in order to give you tax advantages.

By intentionally selling stocks at a loss — capital gains tax owed from realized, profitable trades can be decreased. Losses can offset regular income by up to $3,000 if they exceed gains and any losses over that $3,000 threshold can be carried forward into future tax years. This can really be a difference maker for that final dollar amount on your tax return!

We could go deeper into this subject, but it’s not the central point of the post. Here’s some resources if you want to learn more about tax-loss harvesting:

Wash Sale Rule

So why doesn’t everyone sell their stocks when they are down and buy them back a few seconds later? This would be considered a “wash sale” and it’s not permitted by the IRS for stocks. According to Investopedia…

"The wash-sale rule is an Internal Revenue Service (IRS) regulation that prevents a taxpayer from taking a tax deduction for a security sold in a wash sale. The rule defines a wash sale as one that occurs when an individual sells or trades a security at a loss and, within 30 days before or after this sale, buys a "substantially identical" stock or security, or acquires a contract or option to do so.”

The callout above is that the wash sale rule applies to the sales of securities. As of today, the IRS defines cryptocurrencies assets as property, not securities. According to TokenTax…

“The IRS currently defines cryptocurrency assets as property, not securities. Therefore, it is possible wash sale rules may not apply to cryptocurrency investors.

However, the regulatory landscape for crypto is always changing. It's possible that wash sales for crypto could be explicitly disallowed next year—or next week.

In fact, in 2021, the Biden administration's Build Back Better bill and a House Ways and Means Committee proposal included language applying wash sale rules to digital assets. Although the Build Back Better bill stalled in Congress, these developments underline the government's interest in the matter.”

In short, this rule could go away some time very soon, but that was also said for the entirety of last year. As of now, the crypto wash sale rule is permitted and you’re not doing anything illegal when implementing it.

Here’s some more articles that may help you in your own research:

Final Things to Note

  1. Know the Year: Any actions you take right now would only impact your 2022 taxes (paid next year). If you’re focused on your crypto taxes for 2021 (paid by this April) — see the post below:

  2. What I Use: Many of you have asked what software I prefer for crypto taxes — I found the most luck with CoinTracker last year. And no, this is not sponsored by them in any way.

  3. Decentralized Exchange Trading: Some of you have gone beyond investing on popular exchanges and have bought coins through decentralized exchanges (DEXs). Some popular DEXs include Uniswap, dYdX, PancakeSwap, Curve Finance, and 1inch. If this is you, you may be able to claim tax benefits from your Ethereum gas fees. Here’s a link to learn more.

I hope this is helpful! If you have a family member or friend that invests in crypto, consider sharing this valuable info with them.

Disclaimer: This is not financial advice or recommendation for any investment. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.

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