A young woman walks past a Bitcoin symbol in the storefront of a company that offers blockchain application services.
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Bitcoin took a beating in December – but this drop in prices opens a tax loophole for investors.
The cryptocurrency lost around 18% this month through Thursday, with prices falling to around $ 47,000 per coin. The surge in Covid cases in the United States has been a major catalyst for the decline, which has spread to other popular cryptocurrencies like Ethereum.
However, crypto investors can profit from this loss in ways that stocks, mutual funds, and other investors cannot. This is because the so-called wash sale rules do not apply to crypto transactions.
Crypto investors get a double benefit from this arrangement.
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First, they can sell cryptos at a loss and claim a tax break. (This benefit comes from harvesting tax losses, which allows investors to use a loss to reduce or eliminate the capital gains tax owed on winning investments sold for a gain.) Second, investors can redeem quickly. the crypto they sold to capture any price rebound – which is no exaggeration given the volatility of the crypto.
The first benefit is widely available to investors, but the second is not due to blank selling rules. Anti-abuse rules prevent stock investors from buying an identical or similar security within 30 days before or 30 days after a sale without triggering penalties.
“It allows you to completely manipulate [crypto] on the downside and use it to create a tax [benefit]Leon LaBrecque, financial planner and chartered accountant at Sequoia Financial Group in Troy, Michigan, told CNBC.
Of course, many investors in bitcoin and other crypto may not have a loss on the books. Despite the recent plunge in bitcoin, the coin is up about 62% from 2021 to Thursday, more than double the return of the S&P 500 index this year.
The IRS treats crypto as a property, not as a security (like a stock or a bond), which is how the asset class escapes the white-sell rules under current law.
While the double benefit applies to cryptocurrencies like bitcoin, ethereum, and dogecoin, it would not apply to investors in crypto-related securities.
“You couldn’t dodge the wash with [crypto platform] Coinbase, ”LaBrecque said. “But you can clearly dodge the washout with crypto. “
However, Congress may soon close this tax loophole.
The House’s Build Back Better Act, a package of roughly $ 1.75 trillion investments in social programs and climate change mitigation, would subject crypto transactions to blank sale rules. Legislation has stalled in the Senate amid objections from Senator Joe Manchin, DW.Va., a crucial landmark vote in the equally divided chamber.
Some elements of the legislation may change during negotiations.
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Investors looking to take advantage of the crypto tax loophole can also inadvertently break existing rules if they are not careful.
Crypto sales must always have “economic substance” or investors risk the IRS calling them “sham” transactions, Jeffrey Levine, CFP, accountant and planning director at Buckingham Wealth Partners, based in St. Louis.
The IRS basically wants an investor to bear some economic risk for the sale – which means some risk of loss, Levine said.
Investors who press the sell button on bitcoin and redeem it a second later risk the IRS canceling the tax benefit. But the timing is not black and white.
“Time is always your best argument,” Levine said. “But given the volatility and the fact that it’s constantly trading, I think you have a lot more flexibility with crypto than with anything else.
“A day is more than enough,” he added. “I would feel comfortable defending this before the IRS.”
Even though the crypto is ultimately subject to wash selling rules, investors may be able to bypass them by quickly establishing positions in a different coin without getting tripped up.
Cryptocurrencies are different enough that selling bitcoin and then quickly buying ethereum, for example, probably wouldn’t violate the rules, according to Ivory Johnson, CFP, founder of Delancey Wealth Management in Washington, DC.
“The similarities begin and end with coins traded on a blockchain,” Johnson told CNBC. “Using this logic, stocks traded on an exchange, NYSE or otherwise, are also not considered one and the same.”