Crypto Wash Trading Rules 101

Most investors use the wash sale rule to save thousands of dollars when they claim tax benefits.  However, there are safeguards by the IRS which prevent investors from taking undue advantage of the benefits. Cryptocurrency is categorized as a property and is therefore excluded from the list, which only includes securities.

IRS Wash Sale Rule in the US

They are rules that dictate how and when investors can take advantage of the law to use crypto tax-loss harvesting to offset capital gains with capital losses. The rule applies when a similar security is sold at a loss and bought back within thirty days.

As of September 2022, the IRS classified cryptocurrency as property, which means the same tax rules apply to them as in the case of bonds and stocks. This means you’re mandated to pay taxes on cryptocurrencies when you sell and convert for more than you initially bought them. Moreover, you’re allowed to deduct any losses if you sell for less than the purchase price.

However, there’s one exception to cryptocurrency unlike stocks and bonds; securities are highly regulated to protect investors. Cryptocurrency is highly volatile and therefore, the wash sale rule doesn’t apply, which means the same set of rules applies as with precious metals and other real currencies.

The wash sale rule isn’t all bad for cryptocurrency traders. It means you can purchase when prices are low and buy back the coins as prices bottom out.

When Does the Wash Sale Rule?

As we’ve stated before, the wash sale rule only applies to securities, including:

  • Stocks
  • Bonds
  • Mutual funds
  • ETFs
  • Options
  • Futures
  • Stock warrants

The wash sale rule was put in place by the IRS to prevent investors from claiming tax benefits by selling securities at a loss. This means that violating the wash sale tax rule results in you being ineligible to claim tax benefits that come about through tax harvesting.

What is tax Loss Harvesting?

We’ve talked to a great degree about tax loss harvesting. It’s a situation where investors sell some of their assets at a loss to balance gains they made in other transactions. The IRS allows joint couples to offset up to $3000 during filing while individuals are allowed a tax harvesting of up to $1500 during tax filing.

Moreover, it’s also allowed to carry your loss into subsequent years if you have more than $3,000 losses yearly

Is There a Likelihood of a Crypto Wash Sale Rule?

Most experts predict that there could be a crypto wash rule in the future because over the years, there has been a continued interest in many cryptocurrency coin offerings and this has caught the attention of the Securities and Exchange Commission.

There’s also the likelihood that the proposal in the Build Back Better act could pass legislation, which would subject cryptocurrencies to the wash sale rule. This would mean more tax liabilities for crypto investors when they sell at a loss and purchase new assets. In the meantime, cryptocurrency traders should be excited that the wash sale rule doesn’t yet apply.

Tips to Avoid Wash Sale Rules Violation

It’s crucial to familiarize yourself with the wash sale rule to avoid violating them, which can lead to hefty tax implications.

The most important tip is to ensure you pay the utmost attention to timing. This means abstaining from buying or selling identical securities for 30 days before and after you sell them.

The type of security you trade in is as equally important. The IRS hasn’t given a clear definition of what identical means but it would be best to avoid buying the same type of security to minimize your tax obligation. One of the ways to get around this is trading one type of security for another.

Moreover, consider investing in an ETF instead of a stock, especially if you’ve suffered losses

Identifying Losses in Your Assets

It can be a daunting task to identify an asset that is bringing in losses, especially if you have different wallets and exchanges. In this regard, it can help to invest in a digital ledger, which provides real-time information on how your assets are performing.

What are the Special Considerations for Wash Sale Rule?

Here are some considerations to have at the back of your mind regarding the cryptocurrency wash sale rule:

For starters, securities from one company aren’t considered identical to those of another company.

Number two, cost basis change means that if a particular loss isn’t allowed by the IRS owing to the wash sale rule, the losses must be added to the cost of the new stock and becomes the cost basis of the new stock.

Cryptocurrency losses are exempted from the wash sale rule because as of now, they are considered properties and not securities. As such, you can offset your losses to reduce your tax liability

Benefits of Understanding Cryptocurrency Wash Sale Rule

Getting yourself conversant with the cryptocurrency wash sale rules helps you reduce your tax burden without getting in trouble with the IRS. Here are more benefits of understanding cryptocurrency wash sale rules:

  • Allows you to enjoy tax deductions you’ve planned for instead of having them disallowed.
  • Can help you further reduce your tax burden by carrying forward your losses to subsequent years
  • Helps you minimize losses by understanding when and how to sell digital assets
  • Ensures you’re tax compliant to avoid getting in trouble with the IRS

Wash Sale Rules FAQs

Is there a penalty for violating Cryptocurrency wash trading rules? 

There are no penalties as such. The only thing that will happen is the tax deduction will be disallowed.

What’s the purpose of the wash sale rule? 

The wash sale rule was put in place to prevent investors from gaining an undue advantage by manipulating taxes by preventing them from claiming tax benefits on wash sale transactions.

How can I avoid violating the wash sale rule? 

The surest way of ensuring you abide by the wash sale rule is avoiding buying or selling a similar asset before 30 days lapse after trading in a similar asset. It can help to speak to a financial advisor if you’re unsure of whether you violate the wash sale rule.

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