When Wash Sale Rules Apply to Crypto

Bitcoin fell by nearly 12% recently. Two factors are weighing on the crypto token with the largest market cap. One is that interest rates are going up and the Nasdaq market, which Bitcoin tracks, is falling in anticipation of a slowing economy. The other is that the White House has made it clear that Biden wants to eliminate wash sales of crypto tokens at the same time that it seeks legislation to double taxes on short term capital gains. When wash sale rules apply to crypto, traders will not be able to sell their crypto tokens to take a tax loss and then immediately repurchase the same amount of tokens. Eliminating Bitcoin wash trading will also get rid of something that has been distorting Bitcoin trading by giving the impression of more market trading volume than there really is.

What Is Wash Trading?

When a trader buys and sells securities specifically to distort information in a market, that is wash trading. Historically this action can be carried out by individual traders or by traders who are working with a broker. What has worried regulators (and the White House) is that in some crypto markets as many as seven in ten Bitcoin trades are wash trades. Thus, naïve crypto traders and investors believe that there is high interest in buying Bitcoin at a time when crypto winter has severely dampened interest in crypto by many.

Bitcoin Wash Sales and Taxes

Now, during crypto winter there may be good reasons for someone who owns Bitcoin to want to sell. Some may simply need the money and others may have decided that the crypto market is in danger of falling even more. These folks will generally not turn around and immediately repurchase their Bitcoin within a month which is when the wash sale rule applies to stocks. Those who purchased Bitcoin at the peak in November of 2021 will perhaps want to sell to avoid more loss. They also can write off their loss against their tax obligations for the year in which they make the sale. This is absolutely OK in the stock market. What is not OK is to turn right around and buy the same stock (or Bitcoin) again in the same quantity that they sold.

Wash Sale Rule Enforcement

The internal revenue service will not allow losses in a wash sale to be deducted from a person’s income tax obligations. This rule applies to trading in the stock market. This is the rule that regulators want to impose on trading of Bitcoin and other cryptocurrencies. Under current rules the wash sale regulations apply to stocks and bonds which are securities. Because crypto has not been included in the “security” definition, no crypto tokens are currently subject to the wash trading rule. We have to assume that if the government wants to get rid of the wash trading that is distorting the crypto markets that they will need new laws and regulations in order to apply laws that regulate stocks to the crypto markets.

US Deficit and Taxes on Crypto Gains

Another issue that will weigh on big crypto investors is that Biden wants to raise taxes on the wealthiest Americans in order to reduce the federal budget deficit. One proposal is to double the tax on long term capital gains that investors pay when they sell an asset after holding it for more than one year. While anyone who got into crypto a couple of years ago does not have any capital gains to worry about, those who bought Bitcoin when it was a dollar still have substantial issues with capital gains taxes if they sell. It remains to be seen how the fight over the US budget, the debt ceiling, and all work out on Capitol Hill but the mere suggestion of wash trading regulation along with the prospect of a sinking economy have gotten crypto investors justifiably spooked.

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