Wash Sale Rule — Does It Apply to Crypto?

If you’re an experienced investor, you must have heard about the wash sale rule, which was introduced by the IRS. This rule exists to prevent security holders from exploiting tax deductions. But does this rule also apply to crypto assets?

Here’s all you need to know about wash sale rules and digital currencies.

What Is the Wash Sale Rule?

Wash sale is a term that refers to selling a security or an investment at a loss and buying it again for a similar price. This is why the wash sale rule was invented. Namely, this rule prevents stakeholders from using tax deductions if they sell and buy the same security again within 30 days of the sale.

The purpose of this rule is to stop security holders from abusing the system — i.e., taking advantage of capital losses during taxation. The wash sale rule was adopted by the IRS and it applies to all types of securities, from options and contracts to stocks.

According to US law, when a shareholder buys and sells a certain security within 30 days, they won’t be able to include the losses from that transaction in their reported income. However, wash sale is not an illegal activity. Its only role is to prevent people from claiming losses from sales in tax returns.

As mentioned before, the wash rule time period is set to 30 days before and after the sale of a specific security. Sale dates are also included in this calculation.

Does Wash Sale Apply to Cryptocurrency?

Is there a wash sale rule for crypto? In short, no. The wash sale rules do not apply to crypto because the IRS considers digital currencies to be assets, not security. Unlike traditional wash sale rules, which you can avoid by holding your assets for 30 days, this practice doesn’t apply to cryptocurrencies.

So what is wash trading crypto? Like the traditional wash sale, this is a form of market manipulation in which the main role is played by cryptocurrencies, not securities. This means that crypto investors can claim capital losses after selling their digital currency at a lower price.

Wash trading is not limited only to investors. Crypto exchanges also use this strategy to increase their trading volume and create the illusion of liquidity.

While there are no crypto wash sale rules for digital currencies, the same is not the case with crypto stocks. Namely, this rule applies to the purchase and resale of stocks of companies that are associated with cryptocurrencies.

How Does the Crypto Wash Sale Rule Work?

Crypto wash sale rules involve two things — selling crypto at a loss and buying back your initial coin within 30 days.

Investors can sell any cryptocurrency at a loss, be it BTC or altcoins. Selling crypto coins at a loss will enable them to lower their taxes. To make this work, investors will have to buy back their initial cryptocurrency for a price lower than the one at which they sold it. This transaction can take place 30 days before the sale or 30 days after the sale.

To better understand this rule, let’s take a look at the following examples.

Example 1: You decided to buy 1 ETH at a price of $2,000 which you then sold for $1,000. This means that you lost $1,000 during this transaction. However, if you buy another 1 ETH within 30 days at a price of $1,500, this loss will be disallowed — the cost basis of your new coin will amount to $2,500.

Example 2: You bought 1 BTC for $30,000. However, its value dropped to $15,000 after a certain time, which is why you decided to sell it. This means that you’ve recorded a loss of $15,000. However, within 15 days of selling it, you’ve decided to buy it back for $15,500. This action will allow you to claim $15,500 of capital losses on taxes.

Wash sales bring great benefits to investors since the crypto market is very volatile.

What Is the Crypto Wash Sale Loophole?

We’ve already mentioned that for now there are no wash sale rule crypto laws. This means that crypto holders can take advantage of tax loss harvesting. Tax loss harvesting refers to the sale of cryptocurrencies at a loss and using these capital losses to reduce taxes on future investments.

That said, there is more than one tax loophole investors should be aware of. Besides harvesting their losses, crypto holders can also save money by holding their digital currencies for 12 months. This will reduce their tax burden.

In addition, they can give their crypto coins as gifts or donations. For example, gifts valued under $16,000 are not subject to taxation. The same rule applies to crypto donations that are not taxed by the IRS. Crypto taxes can also be avoided by taking lower incomes during the year. Namely, the smaller your annual income is, the lower your installment on crypto disposals will be.

And finally, there is a way to avoid paying taxes through self-directed IRA accounts. These accounts allow users to store their retirement savings in cryptocurrencies.

That said, this crypto tax loophole could soon be closed since the Biden administration wants to extend the wash sale rule to digital currencies. So keep that in mind.

Conclusion

Wash sale rules indicate selling securities at a loss and repurchasing them for a similar price 30 days before or after the initial sale. The purpose of this rule is to stop the exploitation of tax benefits. Wash sale rules don’t apply to digital currencies since the IRS considers them to be assets, not securities.

This attitude creates loopholes in the law that can bring many benefits to crypto investors. For example, they can take advantage of tax loss harvesting or give away their digital currencies as tax-free gifts or donations.

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