Insights
Crypto Currency “Wash-Sale” Loss Harvesting, August 6, 2021.
In order to understand this fascinating tax strategy occurring today in the crypto currency world, it is imperative to understand the concept of a traditional wash-sale. As a general rule, non-corporate taxpayers may deduct capital losses that outweigh their capital gains by up to $3,000 per year according to Internal Revenue Code section 1211. This means that (without examining specific exceptions), if an individual makes a $1,000 profit from the sale of stock, but also generates a $3,000 loss from a separate sale of stock within the same tax year, the individual will be able to report a section 165 capital loss in the amount of $2,000 (assuming the individual made no other transactions that resulted in capital gains or losses that tax year).
However, an exception is triggered in the event an individual sells a stock for a loss, and repurchases that stock within 30 days of the sale. Per section 1091 of the Internal Revenue Code, a taxpayer may not take a section 165 loss (which included capital losses induced by the sale of securities) if the taxpayer has acquired or entered into an option contract to acquire substantially identical stock or securities within 30 days before or after the day of the sale. This rule is codified in the Internal Revenue Code in order to prevent taxpayers from claiming losses on securities sales solely designed to generate a capital loss. In sum, the IRS is essentially saying, “ If you really want to enjoy the benefit of claiming a loss on your sale of stock, you cannot repurchase that stock within 30 days of selling, because such an action would reflect your true intention to maintain ownership in that stock while simultaneously benefiting from the capital loss you took”. Notably, the IRS makes clear that the rules laid out in section 1091 apply to “stock and securities”. So does section 1091 apply to crypto currency?
No, section 1091 of the IRC does not apply to crypto currency since “convertible virtual currency” (crypto currency) is defined by the IRS as “property” and not a “stock” or “security” for federal tax purposes (2014-16 I.R.B. 938). Without the legal application of section 1091, taxpayers looking to accrue capital losses can currently do so in the exact manner section 1091 prevents. I emphasize currently because I believe it is only a matter of time before the IRS changes crypto’s current “property” tax designation to “stock” or “security”. This will likely change because the lack of section 1091 protections incentives individuals holding crypto currency in a loss position to sell the currency, receive a capital loss in the amount of their loss, and repurchase the same volume of currency at a lower cost basis.
To illustrate with an example, imagine 2 individuals X and Y who each purchased 1000 coins of a crypto currency named AAA for $100,000. After a few months, the 1000 coins of AAA each individual purchased is now only worth $70,000. Individual X sells their 1000 coins of AAA for $70,000 and immediately repurchases 1000 coins of AAA for $70,000. Individual Y continues to hold their 1000 coins of AAA and makes no transaction whatsoever. The clear issue depicted in this hypothetical is that Individual X now has $30,000 in capital losses (yes section 1211 only permits $3,000 per year but the excess carries forward), and individual Y does not have any capital loss even though individual Y currently owns 1000 coins of AAA valued at a total of $70,000 just like individual X.
This insight into cryptocurrency taxation is not to be construed as investment advice. Please contact myself, or an other licensed attorney or tax professional regarding specific inquiries.