Rules and regulations pertaining to cryptocurrency transactions are limited. The only guidance we have is the IRS notice 2014–21.
This notice provided that certain cryptocurrencies, labelled “convertible virtual currencies” are treated as “property” for U.S. federal income tax purposes, and thus, “general tax principles applicable to property transactions” would apply to transactions involving convertible virtual currencies. The Internal Revenue Service (IRS) defined “convertible virtual currencies” as those virtual or cryptocurrencies that had “an equivalent value in real currency, or that acts as a substitute for real currency.” By going with the property definition, gains and losses arising from cryptocurrency transactions are capital in nature, not ordinary income.
I.R.C § 1091.
(a) In the case of any loss claimed to have been sustained from any sale or other disposition of shares of stock or securities where it appears that, within a period beginning 30 days before the date of such sale or disposition and ending 30 days after such date, the taxpayer has acquired (by purchase or by an exchange on which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock or securities, then no deduction shall be allowed under §165 unless the taxpayer is a dealer in stock or securities and the loss is sustained in a transaction made in the ordinary course of such business. For purposes of this section, the term “stock or securities” shall, except as provided in regulations, include contracts or options to acquire or sell stock or securities”.
In simple terms, a wash sale is a sale of a stock or security at a loss and repurchase of the same or substantially identical security 30 days before or after. Wash sale regulations protect against an investor who holds an unrealized loss and wishes to make it claimable as a tax deduction within the current tax year.
Losses arising from cryptocurrency sales are immune to wash sales rules and creates a great tax planning opportunity for certain taxpayers.
Let’s look at the following example:
Imagine you purchased 1 BTC for $5,000 on November 15th, 2018. On December 10th, price of 1 BTC went down to $3,000. If you were to sell this 1 BTC on December 10th, you would incur a $2,000 ($5,000-$3,000) short-term capital loss. Since cryptocurrencies like bitcoin are treated as property by the IRS, this loss, which would typically be disallowed under wash sales rules, is allowed. In other words, if you had the same transaction with stocks, the IRS would disallow $2,000 of short-term loss because you purchased the stock within 30 days prior to the disposition. The idea behind the wash sale rule is to prevent taxpayers from claiming artificial losses. Since this rule is not applicable to cryptocurrencies, in the example above, the taxpayer can claim a deductible loss and can re-enter the position at $2,000 per BTC again.
In summary, capital loss harvesting is a handy year-end tax planning tool. Note that this strategy does not fit every taxpayer. Please consult your tax advisor to see if this strategy is a good addition to your tax plan.
-Shehan Chandrasekera, CPA, Partner, Advisor at BitTaxer
Shehan Chandrasekera, CPA joins BitTaxer from Houston, TX, and is a Partner at Jag CPAs & Co., as well as being a founding member of the Houston Blockchain Alliance. He was one of the first CPAs to have a published academic article on Cryptocurrency, is a sitting member of FinTank, recently spoke at the Global Blockchain Summit in Chicago, and will be speaking at the AI Blockchain Summit in DC at the end of this month. His passion for the space is tremendous, and we’re happy to have him on board.
At BitTaxer, we hope to provide a holistic and comprehensive tax solution for users to account for any type of virtual currency transaction, giving special attention the utility of Virtual Currency as both a capital asset, as well as a method of exchange. BitTaxer is the fastest, easiest, and most accurate way to calculate and file income, deductions, gains and losses from your virtual currency trades. CPA-Approved and works across every device.