Why the Wash Sale Rule Should Be Applied to Cryptocurrency Trading
In my opinion the wash sale rule for securities should be applied to cryptocurrency trading. This rule would help smaller investors avoid potential traps, and would keep those with more money from exploiting loopholes.
What is the wash sale rule? The wash sale is a rule for securities that says when you sell or trade a security at a loss, and then buy or create an option to buy a “substantially identical” security within 30 days, you don’t realize short term losses and instead carry over your original cost basis plus your loss to realize later. This avoids a person having to realize capital losses on assets they trade back into within 30 days.
What is the point of the wash sale rule? The wash sale rule can help protect smaller investors from making bad short term trades in terms of taxes by not forcing them to realize short term losses from mistimed sales, but mostly the point is to stop large investors from tactically taking losses to dodge taxes.
Does the wash sale rule apply to cryptos? The IRS never explicitly said wash sales don’t apply to securities, and the SEC has said maybe some coins are securities, but the IRS says to treat cryptos as investment property for taxes and the wash sale rule only applies to securities…. thus, logically speaking, the rule doesn’t apply to cryptos (or if it does, it isn’t clear that it does). The wash rule isn’t a general rule for all investors, it is a rule for stocks.
Why apply the wash sale rule for small players? If you bought crypto in 2017, then traded at the height of the 2017 bubble in December, and then were back in crypto by 2018 and held until summer 2018, you have epic losses in 2018 and epic gains in 2017. That could result in you having zero money and owing the IRS more than you have! Not only is that arguably unfair on many levels, but practically speaking many average people won’t have the capital to deal with this. Thus we have an uncountable and unknown number of normal people who are CURRENTLY AS WE SPEAK in a giant financial pickle. Not only that, but it only gets worse as the years roll on, your 2018 losses can’t be written off against 2017 gains, and what if you have gains in 2019? Well those are 2019 gains and you can’t write off your 2018 losses against those. So even if you make money back next year, you could still be at net zero after taxes! Simply put, the average Joe could get whittled down to nothing by taxes with a few bad trades over the course of years… all because Joe the crypto trader couldn’t apply the wash rule.
Why apply the wash rule for big players? Big players can get in the same situation as small players, but mostly big players can always enjoy a good capital loss. They always have capital gains in any year, so they can always benefit from a loss. Here the wash rule has the opposite effect, it stops big players from gaming the system by taking “losses” in crypto by trading out of a coin when it is low (taking a loss) and then trading right back and riding it back up (thus never taking any real loss). If you have enough money, because the market is very volatile, you essentially can doge crypto taxes forever if you are clever.
Bottomline:Right now it is very easy for big players to dodge taxes and very hard for small players to avoid getting taken to the cleaners in terms of taxes in crypto. That means big players who have the money to pay can avoid paying while average people who don’t have the money to pay stand to be ruined by not only the volatile crypto market, but by the IRS’s instance on taking 10% – 30% of some ethereal on-paper gains that no longer exist.
Moving forward with reform: In general we need tax reform for the average crypto trader. For the average Joe or Jane it really makes little sense to tax them on cryptos floating around in some exchange account unless they use those cryptos as money or deposit fiat back into their accounts. There is more than one way to offer this. But rules that already exist 1. like-kind, 2. wash rule, and 3. reporting requirements for exchanges would solve 99.9% of the issues. Without like-kind exchange, the wash rule, and reporting requirements many traders will have their lives ruined by crypto and will be unable to pay their tax bills. We expect the average person to tally up crypto profits and losses (near impossible), to treat every trade between coins as being the same as cashing out (absurd), and then we won’t recognize trades back to a crypto within 30 days as effectively being in that crypto the whole time (needlessly harsh). Crypto traders who got into crypto in 2017 have already been ruined, most just don’t realize it yet, they need relief, not un-payable tax bills, fees, and the risk of jail time.