When you sell a capital asset, the difference between the adjusted basis in the asset and the amount you realized from the sale is a capital gain or a capital loss. Selling a security at a lower price than it was purchased qualifies as a capital loss. That is, however, unless you repurchase the same stock or security within 30 days (well technically 61-day window). These sorts of sales are considered wash sales, and they are excluded from the capital loss deduction allowance. So the question is, does the same rule apply to cryptocurrencies? The answer is most likely not. In this article we will explain our reasons why.
The confusing Cryptocurrency regulatory scheme
Cryptocurrency users and exchanges are required to be in compliance with a confusing patchwork regulatory structure. When one looks for guidance on whether the wash sale rule applies to cryptocurrency, he will be overwhelmed by confusing and inconsistent regulatory policies from various regulatory agencies. The IRS considers virtual currency to be property - not securities.
The SEC relied on the Howey test (a United States Supreme Court created test used to determine whether a capital asset is a security), to declare that Bitcoin and Ethereum are not securities; however, Initial Coin Offerings (ICO) may be considered securities. In other words, the SEC says that some cryptocurrencies may be securities; but the IRS has never explicitly given guidance on whether tax rules that apply to securities apply to virtual currency.
What we know for certain is that cryptocurrency, like other types of real and intangible property, are subject to capital gains and losses rules. These rules apply to taxpayers who buy and sell cryptocurrencies for investment purposes, as well as people who spend virtual currencies on goods and services. Like other capital assets, if your capital losses on your cryptocurrency investments exceed your capital gains, you can claim the loss as a deduction on your income tax returns up to $3,000.
That leaves smart investors to ponder: if you sell your cryptocurrency holdings for a loss today, and then re-purchase them at near the same price tomorrow, can you claim a deduction without running afoul of the wash sale rule? The IRS is silent on the issue, but many experts agree that you can indeed.
26 USC 1091 provides the authority
Wash sales are prohibited by Section 1091 of the Internal Revenue Code. Section 1091 does not apply to cryptocurrency. The IRS treats cryptocurrency assets as property. Cryptocurrencies does not fall within the strict statutory prohibition on wash sales of stock or securities. Because the wash sale rule does not apply based on the express language of the statute, crypto investors can probably claim capital losses from coins they sold and repurchased within 61 days.
Of course, the IRS can always change this rule. Section 1091 does allow the IRS to expand the “stock or securities” that trigger the wash sale rule. If the IRS passes a regulation clarifying that Bitcoin and other cryptocurrencies do fall under the jurisdiction of Section 1091, wash sales may be disallowed. It’s safe to assume that the IRS will eventually take the step to disallow wash sales of virtual currency.
This is a crucial time for cryptocurrency investors to advocate for favorable cryptocurrency tax reform. Because it’s conceivable that the tax treatment for cryptocurrency investors can become less favorable to the American taxpayer and more favorable to the government. For example, one possible unfavorable outcome is that the IRS could make the decision to treat cryptocurrency as personal-use property as opposed to intangible property. Capital losses from the sale of personal–use property, such as your home or car, are not deductible. See IRS Publication 523.