Crypto Traders Have Small Window to Avoid Home Tax Scheme

House Democrats’ proposed tax-and-spend package would subject digital assets to two anti-abuse rules that already apply to stocks and other securities. The change will restrict the tools crypto investors can currently use to hedge against potential losses and reduce their capital gains taxes.

The provision enforcing the “constructive sale” rules for digital assets will go into effect as soon as the bill is signed into law. The rules would apply when investors offset short and long positions on an asset to reduce the risk of losing money. Once an offsetting position is taken, they must pay capital gains tax on the long position as if it were sold – even if it was not.

Crypto investors will also have to worry about “wash sale” regulations starting in 2022. Those rules prevent investors from claiming the deduction when they sell an asset at a loss if they purchase a “substantially similar” asset within 30 days before or after the sale. .

The new rules for digital assets are part of several tax code changes Democrats want to take effect quickly, giving individuals and corporations not much time to respond. But there’s at least a shorter window than what investors had in 1997 when the creative selling rules were first implemented on a retrospective basis.

Crypto investors with offsetting positions may want to consider liquidating both positions or selling at least one to avoid being impacted by capital gains taxes under the constructive selling rules, said Shehan Chandrasekhar, head of tax strategy for CoinTracker, a Company that helps people to manage and calculate. tax from their cryptocurrency transactions.

Investors hoping to capitalize on tax savings before the wash sale rules take effect will have two months to “aggressively harvest tax-losses,” Chandrasekhar said, using the strategy to sell cryptocurrency assets at a loss. Referring to, then buying them back at a lower price to reduce future capital gains taxes.

However, investors will need to be careful when transacting later this year and into the next year, said Lisa Zarlenga, a partner at Steptoe & Johnson LLP, which advises clients on issues related to blockchain and digital assets. . Selling a cryptocurrency asset in early January could inadvertently trigger wash sale rules if an investor bought a nearly identical asset less than 30 days ago in December, he noted.

Congress’s official tax scorekeeper, the Joint Committee on Taxation, estimated Thursday that changes to the rules for creative sales and wash sales would collectively bring in about $16.8 billion over 10 years.

‘Outsized Impact’

After making a handful of last-minute changes, the House is likely to vote on its reconciliation package at the earliest on Friday. It will prepare the bill for the Senate, which is expected to make changes before passing.

The provisions on wash sales and constructive sales are similar to those included in a proposal by the Ways and Means Committee in September. They are separate from reporting requirements that would be imposed on cryptocurrency brokers, such as exchanges, under a bipartisan infrastructure deal passed by the Senate that the House may also consider on Friday.

Once the provisions take effect — assuming they remain in the final reconciliation package — it will be “very, very complicated” for cryptocurrency investors and their financial advisors to comply with the regulations, Chandrasekhar said, noting key features. Keeping what sets cryptocurrency apart from others. financial assets.

Cryptocurrency transactions occur more frequently than stocks and other securities and often take place across multiple wallets and exchanges, making them more difficult to track, he said. CoinTracker has found that the average person has three to five wallets and exchanges. In addition, there are platforms that have made it easier for the average person to engage in complex financial transactions, such as shorting, with their digital assets, Chandrasekhar said.

The House bill would also expand the wash sale rules for foreign exchange and commodities, but Zarlenga predicted there would be “outside influence” on the digital asset.

He said the bill would provide a carve out for certain business transactions involving the sale of foreign exchange or commodities – but not digital assets.

There is also an increased risk that wash sale rules will be inadvertently triggered by trades for “gateway” coins such as bitcoin or ethereum, which are bought and sold much more frequently than others, Zarlenga said. A user can convert Ethereum, for example, for a native token of a decentralized finance platform to gain access to that platform.

“There’s going to be a lot of transactions, and potentially it’s going to be so hard to monitor,” she said.

official guidance

Many of the industry’s key questions about proposed legislative changes will not be answered until the IRS and Treasury Department provide guidance on how to interpret the law.

It’s unclear in the law how “substantially similar” would be defined under the wash sale rules, Zarlenga said. Some may assume that an investor must buy and sell a cryptocurrency similar to bitcoin, but that definition is likely to be broad, she said.

Coinbase, the largest US-based crypto exchange, said it would prompt the Treasury and the IRS to adopt “sensible and compliant” regulations for cryptocurrencies.

“As more and more Americans adopt digital assets, these rules should not be so broad as to stifle innovation or impose impractical requirements on citizens,” the company said in a statement.