What is a wash sale and how does it apply to crypto?
Investing in cryptocurrencies has become increasingly popular among investors worldwide. However, with the emergence of this new asset class, tax legislation has also evolved to cover investment activities related to cryptocurrencies. As a result, every crypto investor must be aware of the tax regulations and their implications on their investment activities.
One way investors attempt to take advantage of tax opportunities is through tax loss harvesting. However, when doing so, they must also be familiar with the wash sale rules and how they apply to their country to ensure compliance with tax laws.
What is a laundry sale?
A wash sale occurs when you sell an asset at a loss and buy back the same or substantially identical asset within 61 days, 30 days before and 30 days after the asset’s sale. Taxpayers carry out wash sales to reduce the total amount to be paid as tax.
To curb how traders use wash sales to claim tax benefits, the United States Internal Revenue Service (IRS) has established wash sale rules that prevent taxpayers from selling their securities at a loss and buying them back within 30 days before and after they are sold.
How does a laundry sale work?
Investors conduct wash sales as part of their tax-loss harvesting strategy to reduce their overall tax liability. When carrying out tax losses, investors use their capital losses to offset capital gains in a tax year. The process requires you to sell your assets or securities at a capital loss to offset capital gains. By doing this, investors can reduce the amount they have to pay in taxes.
For example, say you buy 20 shares of a company at a price of $200 per share, and the stock price declines to $180. If you sell the asset, you will realize a loss of $400. It is a wash sale if you buy the same asset again or a substantially similar asset within 30 days before and after the sale.
By implication, you won’t be able to claim the $400 loss on your tax return. Since the loss is already treated as washed, you cannot use it to offset gains in that tax year. Instead, the loss adds to the cost basis of the repurchased stock, which will be $400 plus the amount you bought.
How does the wash sale rule apply to investing in cryptocurrency?
Different countries have specific rules that affect laundry sales. How the rules are interpreted and the state of crypto regulation in the country determines how those rules affect crypto, meaning wash sale rules apply differently to crypto.
The US Internal Revenue Service currently considers cryptocurrencies to be real estate rather than securities. As a result, they are not affected by the wash sale rules. There are ongoing discussions to extend the rule to include cryptocurrencies, but they remain unsuccessful. Until such rules cover crypto, it can be safe to sell crypto at a loss and buy it back within 30 days and still be able to record the loss for tax purposes.
In Australia, you cannot sell an asset at a loss and buy the same asset to gain a tax advantage at any time. The Australian Taxation Office (ATO) discourages wash selling and warns that taxpayers who engage in it risk compliance action and penalties. This rule also affects crypto in some way.
Understand your country’s tax laws
Wash sale rules are sometimes not straightforward, and interpreting tax legislation can be challenging. However, you should still try to understand the tax rules of your country or jurisdiction and how they apply and affect your cryptocurrency investments.
Using the services of a tax professional can help you identify potential wash sales and use effective strategies to make the most of them or avoid them altogether, depending on your country’s tax laws.
