Took a Hit on Crypto? This Tax Tip Could Ease the Pain

Close-up photo of a woman buying cryptocurrency through a smart phone app that is also showing the growth graph.
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If living in near-constant agitation wasn’t enough to fray every cryptocurrency holders’ last nerve, the fractious activity in May must have surely done the trick. Fortunately, there is some good news coming for crypto backers, in the form of a tax loophole.

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The specific categorization of cryptocurrency as “property” instead of “securities” by the IRS will enable digital stockholders to bypass a tax rule that will save them money when filing taxes next year.

That’s good news for crypto investors who recently lived through the dramatic market collapse of the Terra stablecoin ecosystem in early May. Consequently, the crash contributed to the leading cryptocurrency, Bitcoin, going down more than 50% in value from its all-time high in November 2021, per The Independent.

For investors, offsetting capital gains means you can lower your tax consequences. With tax loss harvesting, investors can sell securities at a loss to offset capital gains tax liabilities. If losses exceed gains, taxpayers can use up to $3,000 a year to offset ordinary income on federal income taxes. Losses in excess of $3,000 can be carried over year after year to offset future gains, according to Bloomberg.

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However, a loss from selling stock or mutual fund shares is not allowed by the IRS if, within the period beginning 30 days before the date of the loss sale and ending 30 days after that date, you buy substantially similar securities. The reasoning behind this is to deter investors from selling their losing securities just to claim a quick tax deduction.

By offsetting your loss by buying substantially identical securities, it is a “wash.” You are not entitled to a loss deduction and the tax savings that would have ordinarily come with it.

For tax purposes, the wash rule applies to securities. Cryptocurrency losses are exempt from the wash sale rule because they are not considered securities, but rather property by the IRS. For now, that is.

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If President Biden’s Build Back Better program had somehow managed to pass into law, then commodity, currency and digital asset/crypto investors would have been subject to the wash-sale rule, per Kiplinger.com. As it stands, this tax loophole or rule cannot be applied to cryptocurrencies like Bitcoin, Ethereum and Dogecoin until new legislation defines digital currency as securities or includes them under the wash-sale rule.

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This means that crypto purchasers can sell depreciated investments, count the loss, then bounce back and buy essentially identical stocks. However, playing this quick-sell/quick-buy game might ring alarm bells at the IRS.

Talking to Rochester, NY-based accountant Matt Metras, Bloomberg reports that the IRS could decide to audit crypto holders avoiding the wash rule to excess. Metras, a taxpayer representative, states that the IRS can look into trading and declare that transactions must have some sort of “economic substance” or an acceptable length of time between selling and buying the same type of coin.

The article also warns that if you have held your crypto for less than a year, the sale-for-loss will be considered a short-term capital loss and will be used to offset short-term gains before long-term gains. However, if you are a longer-term cryptocurrency owner who can legally take advantage of side-stepping the wash-sale rule, it behooves you to do so before the government and the IRS decide to change the rules.

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About the Author

David Nadelle is a freelance editor and writer based in Ottawa, Canada. After working in the energy industry for 18 years, he decided to change careers in 2016 and concentrate full-time on all aspects of writing. He recently completed a technical communication diploma and holds previous university degrees in journalism, sociology and criminology. David has covered a wide variety of financial and lifestyle topics for numerous publications and has experience copywriting for the retail industry.

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