Investors Could Benefit from Tax Loophole for Crypto Losses

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Many crypto investors have been pummeled in the past weeks, with the price of Bitcoin and other cryptocurrencies dropping rapidly. There might be a small silver lining however, as this might open the door to a tax loophole, according to CNBC.

See: Millennials Own More Crypto Than Any Other Generation
Find: If You Want to Invest in Crypto Without Investing in Crypto, Consider These Lower-Risk Options

Losses related to cryptos are treated differently than those of stocks and mutual funds, according to CNBC, as the so-called “wash sale” rule doesn’t apply to them.

According to the Securities and Exchange Commission, a wash sale occurs when you sell or trade securities at a loss and within 30 days before or after the sale you buy substantially identical securities, acquire substantially identical securities in a fully taxable trade, or acquire a contract or option to buy substantially identical securities.

The loophole for cryptos is that virtual currencies are treated as property for federal tax purposes, the Internal Revenue Service explains. As such, general tax principles applicable to property transactions apply to transactions using virtual currency.

See: Biden to Crack Down On Tax Evasion by Crypto Investors
Find: Cryptocurrency Jargon: A Guide for the Crypto-Curious

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In turn, crypto investors can somehow benefit from their losses in a couple of ways. First, they can use the tax loss harvesting practice — which is allowed for securities and stocks — meaning they can sell a capital asset at a loss to offset a capital gains tax liability, according to cryptocurrency tax software Cryptotrader.tax. By harvesting a loss, investors are able to offset taxes on both gains and income, a tax reduction strategy commonly used in the world of stocks and securities, Cryptotrader.tax explains.

The second way to benefit from crypto losses, not allowed for stocks and securities under the wash sale rule, is to quickly re-buy the crypto.

“They can sell crypto for a loss, and then use that loss to reduce or eliminate capital gains tax on winning investments. Then, they can quickly buy back the crypto they sold so as not to miss out on a subsequent rebound in price,” according to CNBC.

It lets you completely manipulate [crypto] on the downside and use it to create a tax [benefit],” Leon LaBrecque, a CFP and accountant at Sequoia Financial Group tells CNBC.

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About the Author

Yaël Bizouati-Kennedy is a former full-time financial journalist and has written for several publications, including Dow Jones, The Financial Times Group, Bloomberg and Business Insider. She also worked as a vice president/senior content writer for major NYC-based financial companies, including New York Life and MSCI. Yaël is now freelancing and most recently, she co-authored  the book “Blockchain for Medical Research: Accelerating Trust in Healthcare,” with Dr. Sean Manion. (CRC Press, April 2020) She holds two master’s degrees, including one in Journalism from New York University and one in Russian Studies from Université Toulouse-Jean Jaurès, France.

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