A cryptocurrency tax loophole that’s helped investors save millions of dollars may be closing in the near future.
In this guide, we’ll walk through everything you need to know about the crypto wash sale rule — including how it can help you save money on your tax bill and whether Congress will end this ‘loophole’.
What is the wash sale rule?
Before we jump into discussing the wash sale rule, it’s important to understand the rules around capital losses.
What is a capital loss and how can it reduce my tax bill?
When you sell an asset (such as stocks or cryptocurrency) for a lower price than you originally acquired it, you’ll incur a capital loss.
Capital losses can offset capital gains and up to $3,000 of your personal income. Additional losses above this amount can be rolled forward to future tax years!
As a result, many investors claim capital losses on stocks, cryptocurrencies, and real estate to minimize their tax bills, a strategy commonly referred to as tax loss harvesting.
Example: What is a capital loss?
Michelle has $5,000 of ETH.
The value of Michelle’s ETH falls to $4,000.
Michelle sells her ETH and claims a capital loss of $1,000.
Michelle can use her capital loss to offset $1,000 of capital gains/income.
How does the wash sale rule impact capital losses?
The wash sale rule says investors are not allowed to claim capital losses on a security if they buy the same security 30 days before or after the sale.
The purpose of the law is to prevent people from selling securities simply to reduce their tax liability.
Example: What is a wash sale?
Chase buys $10,000 of Google stock.
After a stock market crash, Chase sells his holdings for $7,000.
A few days later, Chase buys $7,000 of Google stock.
Chase is not allowed to claim a capital loss due to the wash sale rule.
Currently, the wash sale rule applies only to securities (like stocks). However, Bitcoin and other cryptocurrencies are not considered securities. Cryptocurrency is classified as property by the IRS.
As a result, it’s reasonable to assume that the wash sale rule does not apply to cryptocurrency at this time.
How does the wash sale rule impact my tax bill?
For years, investors who’ve taken profits on stocks and cryptocurrencies have used cryptocurrency wash sales to reduce their tax liability.
Because cryptocurrency is so volatile, some investors choose to harvest their losses multiple times in a given year, then re-enter the same positions shortly afterwards while claiming capital losses on their tax returns.
For more information, check out our complete guide to crypto tax-loss harvesting.
What is the economic substance doctrine?
It’s important to remember the economic substance doctrine places some restrictions on claiming wash sales on cryptocurrency.
Due to the economic substance doctrine, the IRS may not allow you to claim capital losses if there is no ‘economic substance’ behind the transaction other than reducing your tax liability. For example, selling cryptocurrency and then immediately re-purchasing it will likely be seen as a transaction without substance.
According to tax experts, selling and then rebuying your cryptocurrency after a few days should ensure that you pass the ‘economic substance’ test. Because the cryptocurrency market is so volatile, it can be reasonably argued that selling and then re-purchasing crypto after a few days has ‘economic substance’.
Will the wash sale rule apply to cryptocurrency?
The Biden Administration’s proposed 2025 fiscal budget would introduce the wash sale rule to cryptocurrency. This is the latest in a series of attempts by legislators to close the wash sale ‘loophole’ — though none have passed into law.
According to experts, it’s very likely that the wash sale rule will be introduced to cryptocurrency in the near future. However, any formal law restricting cryptocurrency wash sales would not be retroactive — meaning that investors can still claim capital losses from wash sales on their taxes until restrictions are put in place.
Am I allowed to claim cryptocurrency wash sales?
Some taxpayers choose to be extremely conservative and avoid cryptocurrency wash sales entirely. However, most tax experts agree that losses from cryptocurrency wash sales can be claimed on your tax return until formal guidance is passed into law.
If the wash sale rule is changed, what does it mean for crypto investors like me?
At this time, the wash sale rule has not yet been expanded to apply to cryptocurrency. As a result, investors can sell their cryptocurrency at a loss, claim a capital loss on their tax return, and re-enter the position shortly after.
Still, investors should be prepared for potential changes at some point in the future. If the wash sale rule is introduced to cryptocurrency, investors will need to record the dates they bought and sold their coins if they wish to re-enter the market while still claiming their capital losses.
How can I tell which one of my assets is currently trading at a loss?
If you hold cryptocurrency in multiple wallets and exchanges, it can be difficult to tell which one of your assets is currently trading at a loss.
Crypto tax software like CoinLedger can help. Once you import your cryptocurrency transaction history, you’ll be able to view all of your tax-loss harvesting opportunities at a glance.
How can I manage my crypto taxes?
If you’re looking for an easy way to manage your crypto taxes and harvest your losses, try CoinLedger. More than 500,000 investors use the platform to save money and simplify the process of crypto tax reporting.
Get started with a free preview report today — there’s no need to add your credit card details until you’re 100% sure your transaction history is accurate.
