A Tax Loophole for Crypto Losses? Here's What You Need to Know

tax loophole for crypto losses
   

It’s been a wild ride for investors of cryptocurrency lately, especially popular ones like Bitcoin and Ethereum that have seen a recent plunge in prices.

There is a small silver lining for those investors, though, as losses related to cryptos are treated differently from stocks and mutual funds. Therefore, the so-called “wash sale” rule does not apply to them.

Here’s everything you need to know.

How Crypto Investors Can Benefit from Recent Losses

Cryptocurrencies are not regulated as securities but are taxed as property instead. That means that the rules that apply to stocks and mutual funds don’t apply to cryptocurrency. 

This offers two benefits to cryptocurrency investors:

  1. You can sell cryptocurrency for a loss and then use that loss to reduce or completely wipe out the capital gains you might have on the sale of other stocks/bonds/real estate etc. This benefit, also known as “tax-loss harvesting,” is also allowed for stocks and other securities.
  2. You can quickly buy back the same crypto asset sold and try to take advantage of a rebound in price without having to wait 30 days. The IRS prohibits stock investors from buying the same or similar securities within 30 days before or 30 days after a sale without triggering penalties (referred to as wash sale).

A Quick Example

Let’s say that you are a Bitcoin investor who bought high, and subsequently, the price significantly dropped as it has over the past few weeks. You can sell your Bitcoin, capture the loss, and get right back in the asset to hopefully ride the price back up. These losses that you captured can offset other gains you might have in the same year.  Again, this is allowed because the “wash sale” rules do not apply to property, which is what cryptocurrency is considered.

Wait — There’s an Important Caveat

However, the IRS could argue that you had no real risk of loss in the transaction if you sold your Bitcoin at 1:30 pm on Tuesday and repurchased it at 1:31 pm Tuesday. Crypto sales must have “economic substance,” or investors could risk the IRS labeling this a sham transaction. There is no black and white rule as to how much time should pass, but given the amount of volatility in the crypto markets, you should consider waiting at least one day before buying back.

We Are Here to Make the Complex Tax Strategies Simple

Regulators may crack down on this “tax loophole” in the future, but it’s unlikely that any rules would become retroactive. If you are planning to use this tax strategy, we encourage you to work with a firm like MGA who can help you make informed decisions, especially as many of the rules are not clearly defined.

As always, we are here to make the complex simple.

Have questions? Let’s talk!

June 10, 2021