The secret crypto tax loophole
Over the past few years cryptocurrency has become mainstream, inspiring investors to pour trillions of dollars into digital currencies like Bitcoin, Etherium and Dogecoin. Even companies like Tesla own over $1.3 billion of Bitcoin.
The IRS caught on to this momentum, and in order to ensure they would be able to levy tax, legislation was passed that treats the digital currency as an asset.
As a taxpayer, that means you’ll have to report any of the following to the IRS:
If you sell cryptocurrency for cash
If you use cryptocurrency to purchase something (like a Tesla!)
If you transfer one type of cryptocurrency to another (e.g., Bitcoin to Dogecoin)
Why is that strange? Well, it’s like mandating that every time you use a US Dollar to purchase a soda, you have to report on your taxes what the value of that US dollar was when you earned it, what the value of that dollar was when you sold it, and if you made any gain or loss when using it to purchase a Coca Cola.
Ultimately, it requires taxpayers to track a lot of additional information about their crypto for tax purposes. Think of crypto more like a share in Apple stock than a currency you can easily use in a store.
The cryptocurrency tax loophole
Okay, so now that I know to treat crypto like a stock, what’s the secret crypto tax loophole?
To understand this, let’s review what happens when you sell a share of Apple stock: In this case, you’re required to report the capital gain or capital loss on your personal tax return. If you sold it for more than you bought it, it’s a capital gain; if you sold it for less than you bought it, it’s a capital loss.
But what happens if you sell a share of Apple at a loss, then rebuy it in the same day? In this case, it triggers an IRS regulation known as the wash-sale rule:
A capital loss will be disallowed when an individual sells or trades a stock at a loss and, within 30 days before or after this sale, buys a "substantially identical" stock.
Why would they not allow the loss? Because you would be able to perpetually capture capital losses to reduce your taxes, and indefinitely defer tax liability on the gain.
As an example, let’s say you purchase a share of Apple stock at $140, and suddenly the price drops to $100. Without the wash-sale rule, you would be able to sell the stock and take a $40 capital loss deduction, then rebuy it with a cost basis of $100. Although it may be $140 only a few days later, you don’t report that gain until you sell the stock again, therefore deferring the tax liability.
Here’s the big secret: Cryptocurrency does not follow the wash-sale rules!
As such, you can take advantage of volatility in the cryptocurrency market, locking in your losses to reduce your tax liability and rebuying to defer your capital gains.
