Cryptocurrency prices have a history of erratic fluctuations. As judged by the total value lost ($1.8 trillion and growing), the current market collapse that began in November 2021 is the most severe crypto bear market ever.
The days of passively watching your Bitcoin holdings increase in value over time are gone. Investors in this market need to investigate all options for maximizing the value of their cryptocurrency holdings, including crypto tax-loss harvesting schemes.
If you plan on using tax loss harvesting, you should know that the Internal Revenue Service (IRS) and other tax authorities strictly enforce the wash sale regulation.
The wash sale rule aims to prevent people from abusing tax-loss harvesting. Many investors have lost much money because of those who broke the regulation.
The crypto wash sale rule’s probable adoption is now the sword of Damocles over cryptocurrency assets. This article discusses this principle and guides adhering to it.
Could a Crypto Wash Sale Rule Happen in the U.S.?
Please note that the current IRS wash sale regulation only applies to securities such as bonds, stocks, and similar financial instruments. Since the IRS does not consider cryptocurrency securities, this regulation does not apply to cryptocurrency transactions.
However, the U.S. government has strengthened its attempts to enact a crypto wash sale law. The Build Better Act was introduced to Congress by the Biden administration in late 2021.
The Senate did not approve the measure even though it had already passed the House. One of the several proposals considered in the bill would have subjected cryptocurrencies to the wash sale regulation.
Nonetheless, the administration keeps trying to reach an agreement with the Senate that would allow for the passage of at least a portion of the law. This opens up the prospect of the wash sale rule’s application on crypto at any moment.
Does cryptocurrency fall under the wash sale rule?
Crypto tax loss harvesting, or the deliberate sale of assets at a loss to reduce taxable income, is used by many investors in the cryptocurrency market.
Bitcoin and other cryptocurrencies are presently classified as property rather than securities by the Internal Revenue Service. Thus, the wash rule does not apply to digital assets now.
In any case, crypto regulations are in a constant state of flux. One year from now, or even next week, it is feasible that authorities may prohibit the practice of “wash trading” in cryptocurrencies.
In 2021, the House Ways and Means Committee proposal and the Biden administration’s Build Back Better bill contained provisions extending wash sale laws to digital assets.
Despite the bill’s Congressional deadlock, these new steps demonstrate the government’s commitment to the issue.
How to Avoid Wash Sale Rule Violations
To effectively claim your tax losses and prevent yourself from breaking any potential future crypto wash sale rules, you may perform one of three things.
Observe the 30-day before-and-after time window
This is the very first basic guideline. The wash sale rule of the Internal Revenue Service does not have an onerous waiting time for coverage.
Successfully claiming a tax loss is most likely to occur if the seller and buyer both stick to the 30-day rule before and after the transaction. Think ahead, and try to acquire the asset you want to avoid selling at a loss 31–40 days before or after the impending sale.
Using this strategy will inevitably make you vulnerable to market swings. However, with some essential preparation and market study, you may find that the price mentioned above fluctuations of your desired asset work to your advantage.
In the case of a longer-term slump in the asset you’re eyeing, for instance, you may want to wait 31 days or more following a losing sale before making another investment.
If, on the other hand, the asset is trending up and is commonly predicted to continue in this pattern, then it is preferable to buy it more than 31 days before the unprofitable sale.
Lastly, if the asset’s price is steady and not in a significant upswing or decline, you are unlikely to lose (or gain) anything by sticking to the 30-day time frame.
Sell your asset and buy a fund-based product with significant exposure to it.
According to the IRS’s wash sale rule, you can’t deduct your expenses if you buy and sell the same thing. The definition of an “essentially comparable product” is complex since it lacks a concrete numerical standard. Investors depend heavily on the IRS’s prior use of the rule to determine whether or not their tax loss claims are secure.
Investors who dump a single company for a fund that has broad exposure to several stocks often get favourable treatment from the Internal Revenue Service. As a result, you may invest in a mutual fund, index fund, or ETF product in which your asset makes up a significant amount of the overall portfolio.
Even if a wash sale rule has not been implemented for cryptocurrencies, it is wise to think about fund-based crypto products. Bitcoin is a substantial component in composite indices for products like the Bitwise 10 Crypto Index Fund and the Galaxy Crypto Index Fund. If your losing sale contains Bitcoins, you may want to think about these goods.
Sell your asset and buy another one with a very high correlation.
A future crypto wash sale rule violation can also be avoided by avoiding the sale of two assets with a significant historical connection. If the values of two assets are highly correlated, they tend to fluctuate similarly and at about the same rates in the market.
The correlation coefficient is used to quantify connections between two variables; its value may vary from 1.0 to 1.0.
A high correlation coefficient (close to 1) between two assets’ prices is very significant. You may minimize your losses from selling an asset at a loss by simultaneously buying or waiting to buy a highly correlated asset or product.
