David Kemmerer anticipates the unintended consequences of proposed new regulations on brokers reporting crypto transactions. Expensive “tax experts” are set to benefit financially, he says, even if ordinary investors won’t.
For years, crypto and NFT investors have leveraged wash sales to save thousands of dollars on their taxes.
However, this “tax loophole” may be ending in the near future. Currently, the Biden Administration’s budget package contains a provision to expand the wash sale rule to cryptocurrency and NFTs and limit crypto investors’ ability to claim capital losses.
What are the tax benefits of capital losses?
To better understand how the wash sale rule works, it’s important to understand how capital losses are taxed.
When you dispose of cryptocurrencies, NFTs or other assets, you’ll incur a capital gain or loss depending on how its price has changed since you originally acquired it.
If the price of your crypto has gone up since you acquired it, you’ll incur a capital gain. If the price of your crypto has gone down, you’ll incur a capital loss.
While losing money is never the goal, capital losses come with a silver lining — tax benefits.
In the U.S., capital losses can offset an unlimited amount of capital gains for the year and up to US$3,000 of income. If you have more than US$3,000 of net losses during the year, you can roll forward your loss into future tax years.
What is the wash sale rule?
Because capital losses can offset gains and other forms of income, investors will often sell their assets at a loss intentionally for tax benefits.
To prevent investors from taking advantage of capital loss rules and offsetting gains and income “inappropriately,” the Internal Revenue Service put the wash sale rule in place.
The wash sale rule states that if you buy a security 30 days before or after selling the same security (or one that is substantially identical), you are not allowed to claim a capital loss on your tax return.
Does the wash sale rule apply to cryptocurrencies?
Based on the current language of the wash sale rule, it’s likely that it does not apply to cryptocurrencies and NFTs at this point in time. Currently, the wash sale rule only applies to “securities” — in other words, stocks and equities.
Notwithstanding the arguments put forth by the Securities and Exchange Commission, crypto-assets are considered “properties” and not ‘securities’ by the IRS, so it’s reasonable to assume that cryptocurrency and NFTs are not currently subject to the wash sale rule. As a result, investors can dispose of their crypto-assets, claim a loss, and then buy back the same asset shortly after.
Because cryptocurrency prices are so volatile, crypto investors have long used the lack of the wash sale rule to claim capital losses. Market downturns often give crypto investors the opportunity for thousands of dollars in tax savings through wash sales.
Is the wash sale rule going to expand to cryptocurrency?
President Biden’s March 2023 budget plan aims to expand the wash sale rule to crypto-assets.
While it’s too early to tell whether closing the “crypto tax loophole” will be passed into law, this is not the administration’s first attempt to expand the wash sale rule. The Build Back Better Act — which failed to pass through Congress — also would have made crypto capital losses subject to the same 30-day restriction.
One thing is clear: Legislators have been looking to expand the wash sale rule to cryptocurrency for years. No matter whether or not the Biden budget plan successfully passes into law, investors should be prepared for the wash sale rule to apply to cryptocurrencies in the near future.
What does the end of the 30-day rule mean for crypto investors?
In our estimation, it’s unlikely that the wash sale rule will be applied retroactively to transactions that take place in the 2023 tax year.
However, the expansion of the wash sale rule means that it’s more important than ever to keep accurate records of your crypto transactions. To accurately report your taxes, you’ll need to keep track of the crypto you’ve bought and sold within the last 30 days.
Manually tracking the holding period for NFTs and cryptocurrencies may be difficult for investors who use multiple exchanges and crypto wallets. Investors in this situation may need to rely on specialized software to handle tracking and reporting their crypto-assets.
What does the wash sale rule mean for the crypto ecosystem?
The expansion of the wash sale rule is indicative of a more aggressive stance that the federal government is taking towards cryptocurrency. For years, crypto was a niche asset class, which means it often escaped the attention of tax authorities and regulators.
Today, cryptocurrency has reached the mainstream — which means that the federal government is paying closer attention than ever to the ecosystem. Recently, the IRS’s digital assets project director announced that more detailed guidance about cryptocurrency transactions is coming in the next 12 months.
It’s clear that the IRS is more serious than ever about collecting revenue from the cryptocurrency ecosystem — which makes it important for investors to accurately track and report their crypto transactions.
The expansion of the wash sale rule may limit crypto investors’ ability to claim capital losses. To prepare for potential changes in tax law, it’s important to keep accurate records of your cryptocurrency transactions — including your holding periods for your crypto-assets.