For years, crypto and NFT investors have used laundry sales to save thousands of dollars on their taxes.
However, this “tax loophole” may come to an end in the near future. Currently, the Biden administration’s budget package includes a provision to extend the wash-sale rule to cryptocurrency and NFTs and limit crypto investors’ ability to claim capital losses.
What are the tax benefits of capital losses?
To better understand how the wash-sale rule works, it’s important to understand how capital losses are taxed.
When you dispose of cryptocurrencies, NFTs, or other assets, you incur a capital gain or loss, depending on how the price has changed since you originally bought it.
If the price of your cryptocurrency has increased since you bought it, you are recording a capital gain. If the price of your cryptocurrency has fallen, you will suffer a loss of capital.
While losing money is never the goal, capital losses come with a silver lining: tax breaks.
In the US, capital losses can offset an unlimited amount of capital gains for the year and up to $3,000 in income. If you have more than US$3,000 in net losses during the year, you can carry over your loss to future tax years.
What is the laundry sale rule?
Because capital losses can offset gains and other forms of income, investors will often intentionally sell their assets at a loss for tax benefits.
To prevent investors from abusing capital loss rules and “improperly” offsetting profits and earnings, the Internal Revenue Service introduced the wash-sale rule.
The wash-sale rule states that if you buy a security 30 days before or after selling the same security (or a security that is nearly identical), you can’t claim any capital loss on your tax return.
Does the wash-sale rule apply to cryptocurrencies?
Based on the current language of the wash-sale rule, it is likely that it does not apply to cryptocurrencies and NFTs at this time. Currently, the wash-sale rule only applies to “securities” — in other words, stocks and shares.
Despite the arguments of the Securities and Exchange Commission, crypto assets are considered “property” and not “securities” by the IRS, so it is reasonable to assume that cryptocurrency and NFTs are not currently subject to the wash sale -rule. As a result, investors can get rid of their crypto assets, claim a loss, and buy back the same asset shortly afterwards.
Because cryptocurrency prices are so volatile, crypto investors have long used the lack of the wash-sale rule to claim capital losses. Market downturns often give crypto investors the chance for thousands of dollars in tax savings from laundry sales.
Will the wash-sale rule spread to cryptocurrency?
President Biden’s March 2023 budget plan aims to extend the wash-sale rule to crypto assets.
While it’s too early to say whether closing the “crypto tax loophole” will be passed into law, this isn’t the administration’s first attempt to expand the wash-sale rule. The Build Back Better Act – which failed to pass Congress – would also have subjected crypto capital losses to the same 30-day restriction.
One thing is clear: lawmakers have been looking to extend the wash-sale rule to cryptocurrency for years. No matter if the Biden budget plan is successfully passed into law, investors should be prepared that the wash-sale rule will apply to cryptocurrencies in the near future.
What does the end of the 30-day rule mean for crypto investors?
In our estimation, it is unlikely that the wash sale rule will be retroactively applied to transactions occurring in tax year 2023.
However, the expansion of the wash-sale rule means that keeping accurate records of your crypto transactions is more important than ever. To accurately report your taxes, you need to track how much cryptocurrency you bought and sold in the last 30 days.
Manually tracking the holding period for NFTs and cryptocurrencies can be difficult for investors using multiple exchanges and crypto wallets. Investors in this situation may need to rely on specialized software for tracking and reporting their crypto assets.
What does the wash-sale rule mean for the crypto ecosystem?
The expansion of the wash-sale rule is indicative of a more aggressive stance the federal government is taking towards cryptocurrency. For years, crypto was a niche asset class, often escaping the attention of tax authorities and regulators.
Today, cryptocurrency has hit the mainstream – meaning the federal government is paying more attention than ever to the ecosystem. Recently, the IRS’s Digital Assets Project Director announced that more detailed guidelines for cryptocurrency transactions are coming in the next 12 months.
It is clear that the IRS is more serious than ever about collecting revenue from the cryptocurrency ecosystem – which makes it important for investors to accurately track and report their crypto transactions.
The expansion of the wash-sale rule may limit crypto investors’ ability to claim capital losses. To prepare for potential changes in tax laws, it is important to keep accurate records of your cryptocurrency transactions, including your crypto asset retention periods.