Increased Funding For Irs Enforcement
The BBB legislation also appropriates roughly $80 billion for IRS operations and taxpayer services, approximately $45 million of which is devoted to beefing up IRS enforcement, including provid digital asset monitoring and compliance activities. The increased funding for IRS enforcement, paired with enhanced crypto reporting requirements in the recently passed infrastructure bill, will surely result in more IRS audits and enforcement actions for crypto investors and miners/validators alike.
Are Cryptocurrencies Shares Of Stock Or Evidence Of Indebtedness
If the answer is no, then the wash sale rule does not apply to cryptocurrencies.
There are some new tokens coming out that represent ownership of stock of a corporation. The wash sale rule would apply to these.
The SEC has suggested that some cryptocurrencies, like ICOs, should be treated as securities, but this is under securities law different from the tax laws.
There is potential that governance tokens might be considered “shares of stock” if a distributed autonomous organization could be classified as a corporation.
Some Digital Asset Actions Are Taxable
Generally speaking, you’re taxed on the crypto you’ve earned or the disposition of your digital assets. Whereas you’re not taxed for crypto movement or transfers between digital wallets or exchanges– unless you’re sending it to someone’s wallet as a gift, at which point gifting tax rules may apply– be sure to ask your accountant how that works. The IRS has a fairly comprehensive FAQ section that outlines a range of transaction scenarios that are worth reviewing for anyone who owns, earns, or trades virtual currencies.
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For Now Cryptocurrency Investors Dont Have To Worry About The Wash Sale Rule But The Days Of Selling And Immediately Repurchasing Virtual Currencies May Be Numbered
You might not realize it by looking at todays booming crypto market performance, but in the not-too-distant past, cryptocurrencies fell to some of their lowest prices of the year. Bitcoin hit an all-time high in May but then quickly pulled back to lower levels. Nearly every cryptocurrency followed suit. This wasnt the first time it happened, and its almost surely not the last.
While this might seem like a distressing situation for investors speculating on these coins long-term appreciation potential, some alert investors welcome opportunities like these with open arms. Why?
The IRS classifies virtual currencies like Bitcoin, Ethereum, Dogecoin or even Shiba Inu as property. This means crypto investors are subject to the same taxes on capital gains and losses that apply to other investors, but with one important difference. They escape one rule that applies solely to financial securities: the wash sale rule.
Why Is The Wash Sale Important To An Investor
For example, if you bought Apple stock for $20,000. The value drops, and you sell it all at $13,000. You have regrets and repurchase it for $13,000 the next day. Later that year, the price soars to $21,000, at which point you sell for a profit. There were two times when the stock was sold once for a $7000 loss, the second for an $8000 gain. You had a net profit of $1000.
What is the tax impact?
Because the wash sale rule applies, you are denied the $7000 loss. Your total capital gain will be $8000. The tax would be about $2000. So because of the wash sale rule, you lost $1000. What???
If the wash sale rule had not applied, you would have had a net capital gain of $1000. The taxes would have been about $250, so you would still be in the black.
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What Is The Economic Substance Doctrine
The economic substance doctrine is a doctrine in US tax law that says a transaction must have economic significance aside from its tax effects. Basically, a transaction that does nothing else but generate tax benefit is invalid under this doctrine. The parties to the transaction must actually incur some economic benefit or suffer some economic loss in order for it to be recognized by the IRS. A transaction that does neither, but still manages to generate some kind of tax benefit, will be invalid under this doctrine. Its become a very powerful tool for the IRS in attacking tax shelters and the courts are generally pretty supportive of the doctrine.
Because a bitcoin wash sale leaves you in the same economic position, but has generated a tax loss for your benefit, I wouldnt be surprised to see the Economic Substance Doctrine used to invalidate wash sales of bitcoins that would otherwise avoid Section 1091.
Example: The IRS audits Bob from the previous example and discovers that he sold bitcoins in order to generate a tax loss, and then immediately repurchased the same amount of coins just moments later. The IRS will claim the transaction lacked economic substance and will disallow the loss.
Indirect Tax Impact For Cryptocurrencies
The BBB Act also makes broad-based changes to the federal tax code that may indirectly impact crypto investors and miners/validators. These changes include a new surcharge on certain high-income individuals, estates, and trusts, and increased funding for IRS enforcement. We discuss the potential tax implications of each of these proposed changes on the crypto industry further below.
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The Ways And Means Committee Proposal For Crypto Wash Sales
Sec. 138153 of the Ways and Means summary document plans to subject digital assets to wash sale rule.
This section includes commodities, currencies, and digital assets in the wash sale rule, an anti-abuse rule previously applicable to stock and other securities. The wash sale rule in section 1091 prevents taxpayers from claiming tax losses while retaining an interest in the loss asset
How Wash Sales Work For Stocks & Cryptocurrency Today
Assume Jennet buys a share of Google stock for $2,000 on January 10, 2021. On January 15, 2021, Google stock is trading at a much lower price of $1,200 per share. If Jennet were to sell her position and buy another share at $1,200, she would NOT be able to claim the capital loss of $800 due to the wash sale rule. Therefore, an $800 loss is disallowed under the wash sale rule.
Substitute Google stock with bitcoin or any other cryptocurrency. Here, Jennet would be able to claim the $800 loss as a capital loss because cryptocurrencies are not subject to the wash sale rule.
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Harvest Tax Losses With Crypto
Right now cryptocurrencies aren’t covered by the “wash sale rule” that stocks are. The recent crypto downturn provides an opportunity to harvest deductible tax losses that can be carried over for years. Say you bought Bitcoin at the market peak of more than $69,000 per coin in October, you can sell those assets at today’s price of $48,732 per coin. That transaction would be logged as a loss on the blockchain.
You can then turn around and immediately repurchase the same number of coins you just sold. Basically, you still own the same number of coins before the sale, but you’ve just locked in a deductible loss that can be spread out for years. While you’re not allowed to do this with stocks because of a required repurchase waiting period, it’s a legal loophole for crypto that’s still available– but will likely be closed soon.
How Long Should I Wait To Repurchase After Selling My Bitcoins For A Loss
Unfortunately, there is no clear answer to this question. Traditionally, the amount of time required to pass in order for a transaction to gain economic substance depended on the volatility of the market. The more volatile, the less time was needed. And visa-versa.
It goes without saying that bitcoin is an extremely volatile asset. So, we can probably safely assume that you do not need to wait very long. 30 days is certainly long enough . Conversely, waiting only a matter of minutes is almost as certainly not long enough.
So, where does the magic number lie? Its impossible to say for certain. One day is probably the shortest amount of time I would recommend, but thats quite risky. Two or three days is probably the shortest amount of time I would recommend, with a week or more being the safest choice for those who want to eliminate the risk of the economic substance doctrine almost entirely. At the end of the day, the decision is up to you just keep in mind that longer is better.
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Bitcoin Crash Opens Door To A Tax Loophole For Investors
- Bitcoin, ethereum, dogecoin and other cryptocurrencies have seen prices plunge in recent weeks.
- These investors can leverage those losses in a way that a typical stock or mutual fund investor can’t.
- That’s because the so-called wash sale rules don’t apply to crypto, according to financial advisors. But there are important caveats.
Crypto investors may be shellshocked by a recent plunge in prices. But that sell-off has a silver lining: It opens the door to a money saving tax strategy.
A bitcoin investor who bought at the mid-April peak and sold low on Wednesday would have lost 54%, for example.
But crypto losses are treated differently than those of stocks and mutual funds. That’s because so-called wash sale rules don’t apply, according to financial advisors.
This offers two benefits to crypto investors: 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.
The first benefit is allowed for stocks and other securities. However, the second benefit isn’t stock investors aren’t allowed to buy the same or similar security within 30 days before or 30 days after a sale without triggering penalties.
There Still May Be A Benefit To Wash Sales
After the rule takes effect, capital losses can no longer be claimed on wash sales. However, there is another tax benefit thatâs available for crypto investors. Losses incurred in a wash sale can be added to the cost basis of an asset if itâs repurchased within 30 days.
To better understand how this works, letâs take a look at an example.
In this case, Carly will pay less in capital gains tax if she decides to sell her Ethereum at a profit.
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How To Avoid Wash Sales
The best way to avoid a wash sale is to simply wait until at least 30 days have elapsed before you buy a security again after selling it for a loss. But beyond this obvious answer, there are a few strategies that could allow you to re-enter the market sooner without violating the wash sale rule.
One option would be to buy another stock in the same sector. For example, if you sell Pfizer at a loss, you could immediately buy Moderna without violating the wash sale rule. Or if you sold Procter & Gamble , you could buy another stock in the Consumer Staples industry like Unilever .
Another option is to rotate index ETFs that are similar but not identical. For example, you could sell shares of an S& P 500 ETF at a loss and then immediately buy shares of a Total Stock Market ETF. The performances of these types of funds have historically been very similar. But their underlying assets are different enough that they shouldn’t be viewed as “substantially identical” securities.
One final option would be buy additional shares of a stock at least 31 days before you plan to sell some shares at a loss. For example, let’s say you bought 20 shares of XYZ stock at $130 and it’s currently selling at $100. If your long-term view of XYZ is bullish, you could buy an additional 20 shares of it at $100. Then 31 days later, you could sell your original shares and harvest their losses if the share price of XYZ is still below $130 at that time.
What Are The Risks Of Tax
If you find yourself in one of these scenarios, tax-loss harvesting may not be right for you.
- You are planning to liquidate your holdings soon: Be cautious of tax-loss harvesting if you are planning to sell off cryptocurrency you’ve purchased within the past 12 months. If you do sell your tokens, you will need to pay the short-term capital gains rate rather than paying the long-term capital gains rate , which may apply if youâve held your tokens for longer than 12 months.
- Your tax savings do not cover exchange fees: Before pursuing a tax-loss harvesting strategy, itâs important to consider exchange fees. Itâs possible that the price to sell and rebuy your tokens is higher than your potential tax savings. â
- Your long-term capital gains are already 0: If youâre single and making under $40,000 or married and making under $80,000, your long-term capital gains tax rate is already 0%. While tax-loss harvesting will not reduce your long-term capital gains tax, it can still offset your short-term gains and up to $3000 of income.â
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Minimizing Your 2021 Crypto Tax Bill
The IRS currently classifies digital currencies like bitcoin as property, so losses on crypto holdings are treated much differently than for stocks and mutual funds.
“One thing savvy investors do is sell at a loss and buy back bitcoin at a lower price,” said Shehan Chandrasekera, head of tax strategy at crypto tax software company CoinTracker.io. “You want to look as poor as possible.”
Chandrasekera added that investors can take advantage of an unlimited amount of losses and “carry them forward into an unlimited number of tax years.”
The bigger the market for cryptocurrencies, the more this happens.
“I see people doing this every month, every week, every quarter, depending on their sophistication,” Chandrasekera said.
Accruing these losses is how investors ultimately offset their future gains and lower the capital gains tax that would apply for other assets. In other words, they reduce what they owe to the IRS.
Quickly buying back the cryptos is another key part of the equation. If timed correctly, buying the dip enables investors to catch the ride back up, assuming there’s a rebound. Digital coins are notoriously volatile, with steep drops often followed by rapid spikes.
Chandrasekera said it’s an increasingly popular strategy among his company’s customers, but he cautioned that thorough bookkeeping is essential.
“Without detailed records of your transaction and cost basis, you cannot substantiate your calculations to the IRS,” Chandrasekera said.
The Closing Window On The Current Crypto Wash Sale Rule Loophole
As 2021 comes to an end, it is crucial for investors in cryptocurrency to revisit their portfolios and the capital gains they have realized during the year. Unlike stocks, where wash sale rules prevent a taxpayer from selling a security at a loss and immediately buying that same stock back, currently, no such rule applies to cyrpto, as the IRS classifies crypto as property and not a security.
The current wash sale rules regarding securities preclude investors from claiming a deduction when they sell a security at a loss if they buy a substantially identical asset within 30 days before or after the sale.
This current loophole for crypto investors is scheduled to end if the Build Back Better Act is passed by the Senate and signed into law . According to the Joint Committee on Taxation, it is estimated that subjecting crypto to wash sale rules would raise $16.8 billion over the next decade.
Given the potential change to the wash sale rules, it will be important to review your holdings and trading activities to capture losses to offset gains from the current year, as the window to do so may be quickly closing.
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Just Don’t Try It With An Nft
Though investors can attempt tax loss harvesting all year long, it’s often considered and executed at the end of the year, according to Andrew Gordon, an attorney and CPA with Gordon Law.
He told Yahoo Finance that a number of his firms clients have used the method this year, especially with their non-fungible token holdings. And the method isn’t for the faint at heart, as many investors often miss or misunderstand the rules, Gordon explained.
Be sure to harvest those tax losses. Send your worthless NFTs to taxlossharvest.eth so you can realize your losses for the 2021 tax year. In return, from taxlossharvest.eth you will receive literally nothing. And with that you will have “realized” your loss on that NFT. #NFTs
The IRS economic substance doctrine explicitly prohibits a tax filer from reporting a loss that has no economic impact. That means investors can’t just sell their crypto, then buy it back at the same price and write it off as a loss. Also, they cannot do this with an NFT, whose selling point is its uniqueness .
For Bitcoin or Ethereum which are fungible, it doesnt matter which piece you have, it’s all the same. Thats not true for NFTs. You typically cant sell and buy back the same one and if you are, then, perhaps, the entire sale is a sham, said Gordon.
“We’ve had people ‘sell’ to their friends then buy it back or they very immediately buy it back in the same instant,” Gordon said. “That’s not going to be accepted by the IRS.”