On September 13, the Ways and Means Commission published a summary report on the ways the US government plans to fund the infrastructure bill. One of them involves closing the loophole in the laundry sales rule – which allowed crypto investors and traders to use a “loss tax harvest strategy” to reduce their tax bill!
What is a laundry sale?
According to Investopedia, a ‘washed sale’ occurs when an individual sells a stock or security at a loss, only to purchase a substantially identical stock or security within 30 days before or after the sale.
This means that traders can claim the loss to reduce their tax bill, as well as buy back the stock or security at a lower price than before!
What is the rule of selling laundry?
The IRS clearly sees “sales laundering” as an attempt to manipulate tax laws to reduce taxes. This is why the IRS introduced a laundry sales rule under Section 1091 of the IRS Code.
The wash-sale rule does not allow an individual to claim a loss incurred from selling a wash for tax purposes. Let us understand with an example:
Joshua bought 50 shares of the company’s stock for $6,000 on May 1, 2020. The company’s shares are trading at a lower price on May 2, 2021. Therefore, he sold 50 shares for $4,000. Within two weeks, he repurchased the same 50 shares for $3,000.
He incurred a long-term initial capital loss of $2,000. But he cannot claim it due to the washed sale rule. If he had bought it again after 31 days, he would be able to claim the loss.
Does the wash sale rule apply to cryptocurrencies?
Currently, the wash sale rule is subject to “Stocks and Securities” only. Per IRS Notice 2014-21, crypto assets are treated as “property.” Because of that the wash-sell rule does not apply to crypto assets at this time.
Example of cryptocurrency laundering sales:
For example, suppose Joshua buys $10,000 worth of bitcoin on January 1, 2021. He sells the same bitcoin for $4,000 on September 7, 2021, making a loss. After 7 days, he bought it again for $5,000. He will claim a loss of $6000, which will reduce his crypto taxes. This is a tax loss harvest.
It is used by many cryptocurrency investors to reduce the crypto tax bill. However, the Internal Revenue Service and the Biden administration are working together to better define regulation and close all the crypto-gaps — to generate the additional tax revenue needed to fund the massive infrastructure bill.
Read more: Suggested changes to the crypto tax laws of 2021 are here
The Ways and Means Committee is reviewing the draft infrastructure law. It is a major tax-writing committee in the United States House of Representatives and has jurisdiction over all taxes, tariffs, and other revenue-raising measures, as well as a number of other programs.
second. 138,153 from a summary report published by the commission, Plans to subject ‘digital assets’ to laundry sale rule:
This section (Section 138153) includes commodities, currencies, and digital assets in the Wash Sale Rule, an anti-abuse rule that previously applied to stocks and other securities. The wash sale rule in Section 1091 prevents taxpayers from claiming tax losses while retaining an interest in the loss principal.
Implications of selling judgment on crypto assets
tax loss harvest
Consider the example of crypto-laundering sales – Joshua’s BTC transaction. Joshua will not be able to claim a loss of $8000 if the crypto assets are also subject to the wash sale rule. However, this does not mean that there is absolutely no benefit from washing sale losses to crypto taxpayers.
The loss incurred during the sale process can be added to the cost basis of the crypto asset purchased within 30 days of the sale. This means that Joshua can add a $6000 laundry sale loss to the cost basis for his newly purchased $5000 Bitcoin. (Total cost basis = $11,000).
Assuming the price of BTC rises after 3 months and Joshua sells Bitcoin for $15,000. He will be responsible for paying a capital gain of $4,000 ($15,000 – $11,000).
If Joshua does not add the wash sale loss to the cost basis for his newly purchased BTC, he will report incorrectly and pay a higher capital gain tax of $10,000!!
As part of the infrastructure bill, all central exchanges in the crypto space will adopt 1099 Information Reports. This means that cryptocurrency brokers/exchanges will use Form 1099-B to report their clients’ gains and losses during the tax year, to the IRS and the client as well.
For those who trade on a single exchange and receive a Form 1099-B, the capital gains reported on the form are accurate. But for those who traded on multiple exchanges, and received Form 1099-B from all exchanges, they may end up paying higher taxes than the actual amount owed. Because when a crypto asset is transferred to or outside a cryptocurrency broker/exchange, the broker will not have the correct cost basis for the crypto asset.
And since exchanges submit the form to the IRS as well, your job will be to collect transaction data from all of your crypto platforms, and track and prove the correct cost basis for your sales. Remember to add the laundry sale loss amount to the cost basis. You can do this manually. Alternatively, you can simplify the process with a crypto tax program like Bear.tax.
If suggestions for ways and means are adopted, the IRS token wash sales rule will apply to “digital assets” after December 31, 2021.
This means that investors still have more than 3 months to use the tax loss harvesting strategy to cut their taxes for the 2021-22 fiscal year without the laundry sale restrictions.
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