A common rule for investing is the wash sale rule. A wash sale occurs when an investor sells a security at a loss and then buys the same security or a very similar security back within thirty days. When this occurs, the investor is not able to deduct the initial loss from the sale of the security. Additionally, investors can incur penalties for having wash sales. This rule was created to prevent investors from creating artificial losses as a way to reduce their total tax liability.
However, many investors have discovered a loophole in the wash sale rule when it comes to investing in cryptocurrency. The IRS specifies that the wash sale rule only applies to securities, and cryptocurrency is considered property, not a security. Therefore, the wash sale rule does not currently apply to buying and selling cryptocurrencies. Investors can sell cryptocurrencies at a loss to cancel out other capital gains and immediately repurchase the cryptocurrencies to capitalize on any future rebounds.
For example, an investor may have purchased Ethereum for about $4,000 and then sold it when it dropped to about $2,000. The investor would have incurred a $2,000 loss. At the same time, the investor could have sold investments that generated a capital gain. The $2,000 loss can be used to offset the investor's capital gains. If the investor had $5,000 of capital gain, the loss from Ethereum would result in only $3,000 in capital gain. The investor could then immediately buy back Ethereum and capitalize on the cryptocurrency in the future when and if the price rises again.
It is important to note that this wash sale rule loophole only applies to cryptocurrencies themselves and does not apply to other crypto-related securities. Additionally, a total net loss of $3,000 or less for a given year is used to offset ordinary income for that same year. If the net loss amount is greater than $3,000, then $3,000 will be used to offset ordinary income from that same year, and the remaining losses will be carried forward to future years.
However, this loophole will likely be gone in 2022. The House Ways and Means Committee is working to change the wash sale rule as it applies to cryptocurrencies. The bill they are working to pass would treat digital assets as if they were stocks and would make cryptocurrency sales subject to the wash sale rule. If the bill does pass, investors will have until December 31, 2021, to take advantage of this loophole.