2024 IRS Cryptocurrency Wash Sale Rules
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2024 IRS Cryptocurrency Wash Sale Rules
For U.S. taxpayers, there are no cryptocurrency wash sale rules, so cryptocurrency wash sales are technically legal.
Navigating Web3 tides with focused insightsBy Tynisa Gaines
Translated by TaxDAO
A wash sale occurs when someone sells a cryptocurrency or security at a loss and quickly repurchases the same or a substantially identical cryptocurrency or security to gain tax advantages. Wash sale rules prohibit selling securities at a loss and repurchasing them within 30 days to prevent taxpayers from reducing their tax liability through "artificial" losses.
For U.S. taxpayers, there are currently no wash sale rules for cryptocurrency, making cryptocurrency wash sales technically legal. However, we recommend avoiding cryptocurrency wash sales, as lawmakers appear to be actively working to close this loophole.
What Is the Cryptocurrency Wash Sale Rule?
Tax loss harvesting is a strategic tool used to minimize tax obligations by selling investments that have unrealized losses. Through this method, investors can realize capital losses, which can help offset capital gains from other investments or up to $3,000 of ordinary income per year.
A wash sale occurs when a holder sells a cryptocurrency or security at a loss and rapidly repurchases the same or a substantially identical cryptocurrency or security, thereby creating an artificial capital loss. If a U.S. cryptocurrency user immediately repurchases their crypto assets after selling, it constitutes a cryptocurrency wash sale. Wash sale rules are designed to prevent investors from claiming losses on assets they still effectively hold. The simplest way to avoid triggering wash sale rules is to wait 30 days after selling an asset before repurchasing it. The challenge with this approach is that prices may change during the 30-day period, potentially affecting returns.
The IRS prevents superficial stock transactions through wash sale rules. Although the IRS has not yet explicitly outlined how these rules apply to cryptocurrency, increasing interest from regulators and lawmakers suggests tighter regulations may soon address this known loophole. Therefore, conservative and risk-averse investors are advised to avoid cryptocurrency wash sales.
How Does the Cryptocurrency Wash Sale Rule Work?
Under Section 1091 of Title 26 of the U.S. Code, losses from wash sales of stocks or securities are subject to wash sale rules. This means that if you own a depreciated investment, you cannot claim a loss on its sale and then repurchase it within 30 days. The rule prevents taxpayers from using "artificial" losses to offset gains and reduce their capital gains tax liability.
The core principle of the wash sale rule is that if an investor repurchases a substantially identical security or crypto asset within 30 days of selling it, the capital loss cannot be used for tax purposes.
Here is an example of how the cryptocurrency wash sale rule works:
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On December 30, Aaron has $15,000 in gains and $5,000 in losses, resulting in a net gain of $10,000. He also holds 20 BNB tokens with a cost basis of $10,000, but their current fair market value is $4,000.
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Aaron sells his 20 BNB tokens for $4,000, realizing a $6,000 capital loss.
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On January 5, Aaron decides to repurchase 20 BNB tokens for $4,200. This repurchase occurs within 30 days of the sale.
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For tax purposes, Aaron reports a $6,000 loss on the 20 BNB tokens to reduce his overall taxable gain from $10,000 to $4,000. However, due to the wash sale rule, this loss is disallowed. As a result, he must pay taxes on the full $10,000 gain.
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Aaron’s cost basis in the newly acquired tokens is adjusted to reflect the disallowed loss.
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If he later sells the new tokens at a profit, the adjusted cost basis will be used to calculate the taxable gain or loss.
How to Use the Cryptocurrency Wash Sale Rule to Save Taxes
Currently, the IRS wash sale rule does not apply to cryptocurrency because the IRS classifies virtual currency as property rather than securities. This effectively means that, as of now, there is no cryptocurrency wash sale rule. Technically, cryptocurrency wash sales are permitted. However, lawmakers and regulators have indicated that this may change soon.
In September 2021, a proposal from the House Ways and Means Committee included language to extend wash sale rules to digital assets—essentially creating a cryptocurrency wash sale rule. Although the "Build Back Better" bill stalled in Congress, these developments highlight government interest in addressing this issue.
President Biden acknowledged in 2021 that the "Build Back Better" bill would not pass by year-end, but he remained committed to advancing the legislation swiftly. In March 2022, President Biden signed the bill into law, calling for federal agencies to pay closer attention to cryptocurrency wash sales. These actions indicate that federal authorities are moving quickly to change legislation regarding cryptocurrency wash sales.
How Do Wash Sale Rules Affect My Tax Bill?
The purpose of a cryptocurrency wash sale is to minimize tax obligations by reducing capital gains. Through a cryptocurrency wash sale, you can legally reduce your tax burden. However, as noted above, this loophole is likely to be closed, so we strongly recommend avoiding wash sales. There are safer strategies that can achieve the same goal effectively:
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Repurchase the crypto asset after the 30-day window. Your transaction will no longer be classified as a wash sale and will protect you from any future cryptocurrency wash sale rules (assuming they mirror existing securities rules).
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Exchange the depreciated asset for another token closely correlated in price. Hold that correlated token for over 30 days before repurchasing the original asset.
Changes to Wash Sale Rules and Their Impact on Investors
If cryptocurrency wash sale rules change, it could significantly impact cryptocurrency investors. Modifications to the rule would affect strategies some investors use to manage their portfolios and minimize tax liabilities. If wash sale rules are expanded to include cryptocurrency, investors will need to reassess their trading behaviors and consider waiting longer before repurchasing assets post-sale to avoid potential penalties. Regardless, we recommend avoiding cryptocurrency wash sales altogether.
Changes to wash sale rules may also lead to increased scrutiny from tax authorities and regulators. Investors should stay informed about any regulatory changes and proactively adjust their tax strategies accordingly.
How Can I Know Which of My Assets Are Currently at a Loss?
Identifying which of your assets are currently at a loss is a crucial aspect of effectively managing your cryptocurrency portfolio. To identify underperforming assets, regularly track the market value of each crypto asset against its initial cost basis. Using specialized cryptocurrency tax software can provide a comprehensive overview of your portfolio’s performance and help identify assets currently in losing positions, streamlining this process.
Using tools like Zerion to regularly review your portfolio and assess individual asset performance enables informed decisions, such as tax loss harvesting or strategic reallocation. By staying vigilant and leveraging available tools, you can optimize your investment strategy and reduce potential losses in the dynamic and volatile cryptocurrency market.
Are Cryptocurrency Wash Trades Legal?
Wash trading in the cryptocurrency market involves artificially inflating trading volume by executing simultaneous buy and sell orders for the same asset, aiming to create misleading market activity.
As of now, wash trading is generally opposed by regulators. However, the legality of wash trading in the cryptocurrency space may vary by jurisdiction. While wash trading is technically legal for U.S. cryptocurrency users, we advise against it, as legislation could change this status.
Cryptocurrency Wash Sale FAQs
Below are answers to frequently asked questions about cryptocurrency wash sale rules.
1. Is the cryptocurrency wash sale rule 30 days?
You cannot claim a capital loss on a security if you purchase the same asset within 30 days of the sale. Therefore, based on current IRS guidance, it is reasonable to assume that wash sale rules do not currently apply to cryptocurrency.
2. Do wash sale rules carry over into the next year?
Yes. If you sell an asset and reacquire it within 30 days, it is considered a wash sale regardless of whether the transaction spans into the next calendar year. For example, selling on December 15 and repurchasing on January 1 constitutes a wash sale.
3. Can you still perform wash sales with cryptocurrency?
Technically, yes—there is currently no cryptocurrency wash sale rule. However, the Biden administration has begun scrutinizing cryptocurrency cases more closely, and the current loophole allowing cryptocurrency wash sales will likely be closed soon, rendering such practices illegal.
4. How can I know which of my assets are currently in a losing position?
The only way to understand your overall portfolio performance is to track all cryptocurrency profits and losses.
5. The Future of Cryptocurrency Wash Sale Rules
Given recent developments in cryptocurrency regulation, including the enactment of the "Build Back Better" Act in March 2022, changes to cryptocurrency wash sale rules are reasonably expected. This legislation empowers federal agencies to focus more intently on cryptocurrency wash sales, signaling growing interest and potential regulatory shifts in the crypto space.
With the Biden administration expressing strong interest in crypto-related matters and enforcement becoming stricter, the legal status of crypto wash sales may change soon. Therefore, caution is advised. Stay updated and proactively adapt your strategies as the regulatory landscape evolves.
6. Can you sell cryptocurrency at a loss and buy it back?
Yes, you can sell cryptocurrency at a loss and repurchase it at any time. When traders do this rapidly to avoid tax consequences, it triggers wash sale rules. For tax safety, the best practice is to wait 30 days from the sale date before buying back.
7. How can you bypass the wash sale rule?
The easiest way to avoid triggering the wash sale rule is to wait 30 days after selling an asset before repurchasing it. The IRS wash sale rule states that if a trader sells a security at a loss and repurchases it within 30 days, the initial loss cannot be claimed for tax purposes.
8. Are wash sale losses disallowed for cryptocurrency?
At the time of writing, there is no effective cryptocurrency wash sale rule for U.S. taxpayers, and cryptocurrency wash sales are technically legal. However, with legislative proposals underway, this situation is expected to change.
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