Polygon Advisory Group LLC

As part of the negotiations around the “Recovering America’s Wildlife Act” (House version & Senate version) currently making the rounds in Congress, lawmakers are taking aim at the wash sale rules that currently don’t apply to crypto losses as a means to fund the bill. But what are wash sales, why don’t they currently apply to crypto trades, and how are they useful? Let’s dig in.

Wash Sale Rules

The wash sale rule is a tax rule that applies to the sale of securities, such as stocks or bonds, found in §1091 of the Internal Revenue Code. The rule is intended to prevent taxpayers from claiming a loss on the sale of a security if they repurchase substantially identical securities within a certain period of time before or after the sale.

Under the wash sale rule, if a taxpayer sells a security at a loss and then repurchases substantially identical securities within 30 days before or after the sale, the loss on the sale is not deductible for tax purposes. Instead, the loss is added to the cost of the new securities, and the taxpayer must wait until they sell the new securities to claim a deduction.

The wash sale rule applies to both individual taxpayers and businesses. It is important to note that the rule only applies to substantially identical securities, meaning that they are the same security or have the same underlying assets. For example, if a taxpayer sells shares of ABC Corporation and then buys shares of XYZ Corporation within 30 days, the wash sale rule would not apply, as the two companies are not substantially identical.

Cryptos Aren’t Securities, Yet…

Because cryptocurrencies are held to be general property by the IRS, they don’t fall under the definition of “securities” as it is used in the §1091 rules. Because of this, crypto traders can actively harvest tax losses by selling crypto assets at a loss and immediately re-buying those assets and still claim those losses on their tax returns. The end result is that their portfolios remain largely the same as they were before the sale — they hold the same underlying crypto assets in the same amounts, less whatever transaction fees were paid. The only difference is that the loss on the original sale is recognized for a tax benefit.

Potential Changes in the Future

It is clear from some of the discussions around the “Recovering America’s Wildlife Act” that Congress is privy to a mismatch in treatment of crypto wash losses as compared to wash losses sustained by a person trading traditional securities. The idea is not new — similar rumblings were heard during the Infrastructure Bill negotiations and over the summer when the Lummis-Gillibrand “Responsible Financial Innovation Act” was first introduced — but the recent debate over how to pay for the Wildlife Act has given the debate new legs in Congress.

While it remains to be seen if this latest discussion will be the end of recognized losses on crypto wash sales, it is important to recognize that the development of new legislation on this topic will be a complex and ongoing process. It may take some time before any changes are implemented. In the meantime, investors & traders should continue to be aware of the current rules and regulations that apply to cryptocurrency transactions and consult with a tax professional if they have any questions or concerns.