What Are The IRS Crypto Wash Sale Rules?
A wash sale is when investors artificially inflate their losses by selling and repurchasing assets.
In response, the IRS has implemented specific rules to stop investors from exploiting artificial losses.
This guide covers everything you need to know about wash sales and the impact on your tax bill.
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.
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, or 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.
You would then sell these to create a realized loss, and then buy them all back immediately at the lower price before the market changes again.
Technically, you don’t really have a loss as you’ve reinvested proceeds back into the same asset, meaning you have the same assets you always had. But you do have an artificial loss you can use to reduce your tax bill.
As you can probably imagine, this is easily exploited, which is why the IRS has put in stringent rules to try stop investors from creating artificial losses through a wash sale.
How does the wash sale rule work?
The wash sale rule stops investors from claiming a capital loss on the capital assets that they sold and repurchased within a short period. This time period spans 30 days before and after the date of the sale.
Let’s put it into perspective 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 (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.
On January 10, she purchases 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.
This 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.
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 short answer is no. The U.S wash sale rule currently only applies to assets that are classified as securities: Stocks, bonds, and other financial instruments.
The majority of cryptocurrencies aren’t classified as securities. Instead, the IRS classifies them as property, and as such, the IRS wash sale rule doesn’t apply to crypto.
Economic Substance Doctrine
It’s important to consider the Economic Substance Doctrine when claiming wash sales on crypto. This common law doctrine denies tax deductions when the related transaction lacks an underlying economic purpose.
Basically, 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 that the wash sale rule doesn’t apply to crypto yet, many opportunistic US investors make the most of this tax loophole.
They seize tax loss harvesting opportunities strategically throughout the year, by utilising dips in the market to sell their assets at a loss (and often repurchase them at a lower price) to lower their tax bill.
How to use a crypto portfolio tracker to identify losses
Koinly is both a crypto tax calculator and a crypto portfolio tracker, helping you keep track of your crypto portfolio performance on a macro and micro level.
You can use Koinly to view your realized and unrealized gains and losses throughout the financial year. As well as identifying assets that are underperforming, so that you can utilize them 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.
