Do you know what the definition of a loophole is? It simply means a way of escape. It can also mean a small opening. Maybe you are wondering what kind of loophole you could find when it comes to Bitcoin or cryptocurrency tax losses. There just happens to be an “escape” that can benefit you.
Does the Wash-Sale Rule Apply to Security Sales Losses?
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Currently, the IRS classifies Bitcoin and other cryptocurrencies as “property.” Each gain or loss transaction counts, right? When you make a poor investment in a taxable security like a brokerage firm, you are allowed to claim a capital loss deduction when you sell it, within some limits. However, the wash-sale rule may disallow your loss under certain conditions. If the tax code disallows the loss, you end up end the hole.
Since cryptocurrency is property instead of securities, the wash-sale rule doesn’t apply. You do have long-term and short-term capital loss based on your holding period before reselling or rebuying it. This is a good thing since you understand how volatile cryptocurrency prices can be. However, this volatility provides you with two great opportunities:
- You can benefit from profits when there are upswings
- You can benefit from loss harvesting when there are downswings.
Let’s take an in-depth look at harvesting losses.
- Day 1 – You pay $50,000 for cryptocurrencies.
- Day 50 – Yes sell your cryptocurrencies for $35,000. Then you deduct the loss of $15,000 on your tax return.
- Day 52 – You buy the same cryptocurrency for $35,000. Your tax basis is now $35,000.
- Day 100 – You sell the cryptocurrency for just $15,000. You can now deduct the $20,000 loss on your tax returns.
- Day 103- You buy the same cryptocurrency for $15,000.
- Day 365 – Now the cryptocurrency is trading at a whopping $55,000! You are a happy camper.
For the long-term, you got to keep your cryptocurrency while banking $35,000 in losses.
Stay Alert and Proceed Cautiously
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In some instances, the wash-sale rule still applies to losses. For example, Coinbase is classified by the IRS as crypto-related security. Cryptocurrencies alone are not classified as securities. If you want to benefit from gains and losses, make sure to deal only in cryptocurrency and not in securities.
The Future of Cryptocurrencies
You are well aware that the IRS is keen on cryptocurrency gains that don’t get reported on tax returns. In fact, the governmental agency is devoting a substantial number of resources to it. In the future, it’s entirely possible for cryptocurrencies to be reclassified. If they are reclassified as securities, then they will become subject to the wash-sale rule. However, we are pretty sure that if that happens, it won’t simply come from the IRS, it would be a major change in tax law.
Conclusion
As per the law today, cryptocurrency losses remain exempt from the wash-sale rule. This is simply because they are not classified as securities. If you have some capital gains that need sheltering, carefully consider tax-loss harvesting using cryptocurrency. You can leverage it as a tax reduction tool. However, please do not jump into cryptocurrency just to attempt tax-loss harvesting.
