Capital loss is usually undesirable, and in general, you wouldn’t wish losing money while investing. But in certain scenarios, taking on planned, short-term losses may provide tax benefits in the long run.
Particularly, this applies to cryptocurrency investments. Thus, with proper crypto tax planning, crypto investors may offset their capital gains using calculated capital losses on crypto assets.
However, effective tax-loss harvesting for crypto assets isn’t a cakewalk and involves various considerations. You’ll need a good grasp over the wash sale rule, for instance.
What is the wash sale rule?
The ‘wash sale rule’ is a financial regulation, issued by the U.S. Internal Revenue Service (IRS), preventing taxpayers seeking tax deductions for capital loss incurred on wash sales. This rule applies specifically to securities like stocks, bonds, mutual funds, options, futures, and ETFs.
The IRS defined ‘wash sale’ in its Publication 550, 2021. Per this definition, you commit a wash sale if, within thirty days before or after trading securities at a loss, you:
- Buy any substantially identical securities or acquire them in a fully taxable trade.
- Invest in contracts or options to purchase substantially identical securities.
- Acquire substantially identity securities for your Individual Retirement Account (IRA) or Roth IRA.
Basically, the wash sale rule allows taxpayers to claim tax deductions for organic losses. More importantly, it prevents them from manufacturing artificial losses merely for tax purposes to circumvent due tax liabilities.
Does the wash sale rule apply to cryptocurrencies?
No, the wash sale rule doesn’t apply to cryptocurrencies as of December 7, 2022. This is because the IRS classifies cryptocurrency as “property” while the wash sale rule applies specifically to securities.
Because of this classification, cryptocurrency investors may legally offset capital gains taxes using losses on cryptocurrency transactions. They can also be eligible for tax deductions up to $3,000 on their annual ordinary income.
Given the significant volatility in crypto markets, you may want to consider selling loss-making digital assets and repurchasing them long-term. If planned well, this can help reduce your annual tax bill.
How to comply with the wash sale rule while using crypto?
Although the wash sale rule doesn’t apply directly to cryptocurrencies at this moment, it may in future. U.S. President Joe Biden’s Build Back Better Act, for instance, attempted to extend the wash sale rule to cover cryptocurrencies.
Notably, however, only cryptocurrencies like bitcoin, ethereum, or similar digital currencies are exempt from the wash sale rule. Contrariwise, it does apply to the securities or stocks issued by publicly-traded companies dealing in crypto. For example: the Coinbase Global, Inc. (NASDAQ: COIN) stock.
Therefore, it’s advisable that you consider compliance with the wash sale rule while planning crypto taxes in case the rules change in the future. This can be done by following the 61-day waiting period whenever possible.
It’s also possible to trade one crypto asset for another, usually correlated ones to avoid repurchasing “substantially identical” assets. This further helps diversify your digital assets portfolio, which is preferable in general.
How to identify loss-making crypto investments?
So far, we’ve discussed the various technicalities of the crypto wash sale rule. Now, let’s consider one of the most crucial aspects of making well-informed tax-loss harvesting decisions, i.e. identifying loss-making assets.
Choosing the right kind of virtual currencies is a prerequisite for making effective crypto tax-loss harvesting strategies. It’s thus better to closely follow your crypto asset portfolio alongside other investments. This may help with devising your tax strategy, providing a clear picture of the overall gains and losses.
Furthermore, Public provides a single platform to manage stocks, ETFs, bonds, crypto, and other investments. Public’s AI Agents allows investors to automate investing workflows while remaining in control of their investment decisions.
Explore the Public app to learn more about its investing tools and agentic workflows.
