What Are The IRS Crypto Wash Sale Rules?
A wash sale is when investors artificially inflate their losses by selling and repurchasing assets, and the IRS has specific rules to stop investors from doing this - but does the IRS wash sale rule apply to crypto? Learn more in our IRS crypto wash sale rule guide.
Key points
A wash rule is when an investor sells an asset at a loss and then repurchases the same kind of asset, effectively creating a paper loss.
Rules exist to prevent investors from utilizing these losses for tax advantages, but there is currently a loophole that means the IRS wash sale rule does not apply to crypto.
Whether this loophole will be closed under new legislation remains to be seen given the new administration.
What is a wash sale in crypto?
A wash sale is when an investor sells an asset at a loss and later repurchases the same kind of asset - or a substantially similar asset.
For example, if you had a large Capital Gains Tax bill looming - you could quickly look through your unrealized losses to figure out how many crypto assets you need to sell, sell these to create a realized loss, and then buy them all back immediately at the lower price before the market changes again. You don’t really have a loss as you’ve reinvested proceeds back into the same asset - so you’ve got the same assets you always did. But you do have an artificial loss you can use to reduce your tax bill.
This is very easily exploited, so the IRS has put in stringent rules to try and stop investors from creating artificial losses through a wash sale. This is a rule that generally stops investors from claiming a capital loss from capital assets that were sold and repurchased in a short period of time.
How does the wash sale rule work?
The wash sale rule is easiest to understand with an example:
On December 30, Sarah has $20,000 of gains and $8,000 of losses, for an overall gain of $12,000. She is also holding 100 shares of Apple Inc. (AAPL) with a cost basis of $10,000, but the current market value of those shares has fallen to $7,000.
Sarah decides to sell her 100 shares of AAPL for $7,000, realizing a capital loss of $3,000.
Within 30 days before or after the sale, Sarah could buy the same or a substantially identical security. So, on January 10, she decides to purchase 100 shares of AAPL for $7,500.
On her taxes, Sarah reports the $3,000 loss on the 100 shares of AAPL and uses it to offset her capital gains, lowering her overall gains from $12,000 to $9,000, which is correct since the wash-sale rule applies. Her loss of $3,000 is disallowed for tax purposes.
The cost basis of Sarah's new 100 shares of AAPL is adjusted to reflect the disallowed loss. So, her adjusted cost basis for the new shares is $7,500 - $3,000 = $4,500.
If Sarah decides later to sell the new shares of AAPL for a gain, the adjusted cost basis of $4,500 is used to calculate the taxable gain.
Does the wash sale rule apply to crypto?
The IRS does have a wash sale rule. The US wash sale rule occurs when an individual investor sells or trades an asset at a loss and buys back a "substantially identical" asset within 30 days. If an investor does this - they cannot claim a capital loss.
But, the US wash sale rule currently only applies to assets that are classified as securities - like stocks, bonds, and other financial instruments. So for example, if you purchased GME stock, sold it at a loss, and then repurchased it, you wouldn't be able to claim this as a capital loss because of the IRS wash sale rule.
The majority of cryptocurrencies aren’t classified as securities by the IRS, it’s classified as property. So right now, the IRS wash sale rule doesn’t apply to crypto.
This said - the wash sale rule will apply to crypto-related securities like stocks in exchanges.
Will the wash sale rule apply to cryptocurrency?
Before you rejoice - this is potentially going to change in the near future. In March 2023, Biden's proposed a series of tax reforms for crypto in the Federal Budget, one of which was including crypto in the wash sale rule. It's estimated more than $24 billion could be raised from this change. However, as the administration has now changed - and the new administration looks set on keeping remaining tax loopholes - whether this goes ahead remains to be seen.
And a further word of warning, you need to consider the economic substance test. This common law doctrine denies tax deductions when the related transaction lacks an underlying economic purpose. In other words, if you're seen to be deliberately selling assets for the singular purpose of tax loss harvesting, then you're not conducting the transaction for a meaningful or substantial economic purpose. As such, there is the potential risk that these losses would not be deductible against gains.
How does the wash sale rule impact my tax bill?
Given the wash sale rule doesn’t apply to crypto yet, many opportunistic US investors make the most of this tax loophole and seize tax loss harvesting opportunities strategically throughout the year.
Learn more in our crypto tax loss harvesting guide.
How to use a crypto portfolio tracker to identify losses
Koinly isn’t just a crypto tax calculator, it’s also a crypto portfolio tracker that can help you keep track of your crypto portfolio performance on a macro and micro level. You can use Koinly to view both your realized and unrealized gains and losses throughout the financial year and to identify assets that are underperforming for tax loss harvesting purposes before the end of the financial year.
FAQs
Does the IRS wash sale rule apply to crypto on Coinbase?
No. The IRS wash sale rule doesn't yet apply to crypto at all - so your trades on Coinbase won't be effected yet. This said, if you're seen to be making trades to gain a tax advantage by creating artificial losses, you may also need to consider the economic substance test as this may also disallow your losses.
How does a wash sale effect a subsequent loss?
If you make a wash sale and have a loss, you won't be able to offset this loss against gains. Instead, the cost basis of your 'newly' acquired asset is adjusted to include the disallowed loss. However, this does depend on the type of asset you've wash traded, as the rule does not yet apply to crypto, but does apply to other assets like stocks and securities.
What if I made a wash sale but didn't gain?
The wash sale rule exists to prevent users from artificially harvesting losses for a tax advantage. So if you didn't gain, it doesn't matter. The rule will still apply and your loss will be disallowed.
How do I make a wash sale calculation?
A wash sale calculation adds the loss from a sale to the basis of a replacement security if the replacement is purchased within 60 days. This calculation prevents investors from claiming capital losses as tax deductions. The method to calculate a wash sale is:
Identify the sale as a wash sale
Determine if the replacement security was purchased within 60 days
Add the loss from the sale to the basis of the replacement security
What is the wash sale 61 day rule?
If you've sold an asset at a loss, you'll need to wait 31 days to repurchase the same (or a substantially similar asset) to avoid triggering the IRS wash sale rule. However, this rule applies to both 30 days before and after the sale, so in total you'll need to account for 61 days when planning your trading to avoid triggering the wash sale rule.
Does the wash sale rule apply to gains?
No. The wash sale rule only exists to prevent investors from creating artificial or paper losses in order to gain a tax advantage. It does not apply to gains, so if you sell an asset for a gain and purchase the same or a substantially similar asset within a short period of time, the wash sale rule does not apply.
