The Bitcoin crash opens the door to a tax loophole for investors

Chris Ratcliffe / Bloomberg via Getty Images

Crypto investors may be shocked by a recent drop in prices. But this sell-off has a silver lining: it opens the door to a money-saving tax strategy.

Popular cryptocurrencies like Bitcoin and Ethereum have lost more than half of their value in volatile trading in the past month.

For example, a Bitcoin investor who bought (around $ 65,000) in mid-April and sold low on Wednesday (close to $ 30,000) would have lost 54%.

However, crypto losses are treated differently than stocks and mutual funds. This is because, according to financial advisors, no so-called “wash sale” rules apply.

This gives crypto investors two benefits: they can sell crypto for a loss and then use that loss to reduce or eliminate capital gains tax on profitable investments. Then they can quickly buy back the crypto they have sold so as not to miss a later price hike.

The first benefit (known as “Tax Loss Harvesting”) is allowed on stocks and other securities. The second benefit, however, is not that stock investors are not allowed to buy the same or a similar security within 30 days before or 30 days after a sale without incurring penalties.

“This is a loophole, so to speak,” Ivory Johnson, certified financial planner and founder of Delancey Wealth Management in Washington, said of crypto in terms of tax regulations. “It’s heads that I win, tails that you lose.”

Crypto tax benefit

The so-called loophole is due to the fact that regulators do not regard cryptocurrencies as “securities”. Instead, the IRS is taxing them as property, Johnson said.

According to financial advisors, the tax treatment could make a big difference for an asset as volatile as the cryptocurrency has been for the past few weeks.

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Take the example of a Bitcoin investor who bought high and sold low, causing a loss of $ 35,000. That year the same person also sells stocks and mutual funds for a profit of $ 35,000. The bitcoin loss would erase taxes on capital gains.

Furthermore, the same investor could have quickly bought Bitcoin again near its $ 30,000 lows and participated in each ramp-up. Its price rose more than 10% on Monday. Some bitcoin bulls expect the asset to hit $ 100,000 by the end of the year.

In comparison, a stock investor would miss out on potential profits 30 days after a sale because of the wash sale rules.

“With that you can manipulate completely [crypto] on the downside and use it to create a tax [benefit]”said Leon LaBrecque, CFP and accountant with Sequoia Financial Group in Troy, Michigan.

While this tax break applies to cryptocurrencies like Bitcoin, Ethereum, and Dogecoin, it doesn’t apply to investors in crypto-related securities.

“You couldn’t avoid the laundry [crypto platform] Coinbase, “said LaBrecque.” But you could clearly dodge the laundry with crypto. “

Precautions

There are important caveats, however.

According to financial advisors, regulators could take action against these rules in the future. However, it is unlikely that transactions that take place before a clampdown would be canceled.

The IRS declined to comment on this story. The Securities and Exchange Commission did not respond to a request for comment.

Investors can also accidentally break other existing rules if they are not careful.

According to Jeffrey Levine, CFP, accountant and chief planning officer at Buckingham Wealth Partners in Long Island, New York, crypto transactions must still have “economic substance” or investors risk the IRS calling them “bogus” transactions.

The IRS essentially wants an investor to bear some economic risk on the sale – which means some risk of loss, Levine said.

Investors who click the Bitcoin sell button and buy it back a second later risk the IRS negating the tax break. But the timing isn’t black and white.

“Time is always your best argument,” said Levine. “But given the volatility and the fact that it is being traded all the time, I think that you are much more flexible with crypto than with anything else.

“One day is more than enough,” he added. “I would be comfortable defending this to the IRS.”

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