Investing in cryptocurrencies has become increasingly popular among investors worldwide. However, with the rise of this new asset class, tax laws have also been evolving to cover investment activities related to cryptocurrencies. As a result, every crypto investor must be aware of the tax regulations and their implications on their investment activities.
One way investors attempt to take advantage of tax opportunities is through tax loss harvesting. However, in doing so, they must also be familiar with the wash sale rules and how they apply to their country to ensure compliance with tax laws.
What Is a Wash Sale?
A wash sale occurs when you sell an asset at a loss and repurchase the same or substantially identical asset within 61 days, 30 days before and after the asset's sale. Taxpayers carry out wash sales to reduce the total amount payable as tax..
To curb how traders use wash sales to claim tax benefits, the United States Internal Revenue Service (IRS) set up wash sale rules that prevent taxpayers from selling their securities at a loss and repurchasing them within 30 days before and after they are sold.
How Does a Wash Sale Work?
Investors carry out wash sales as a part of their tax-loss harvesting strategy to reduce their overall tax liability. When carrying out tax loss harvesting, investors use their capital losses to offset capital gains in a tax year. The process requires selling your assets or securities at a capital loss to offset capital gains. Doing this allows investors to reduce the amount they must pay as tax.
For example, say you purchase 20 shares of a company at a rate of $200 per share, and the share's price reduces and falls to $180. If you sell the asset, you will realize a loss of $400. It is a wash sale if you buy the same asset again or a substantially similar asset within 30 days before and after the sale.
By implication, you won't be able to claim the $400 loss on your tax return. Since the loss is already considered washed, you cannot use it to offset gains in that tax year. The loss instead adds to the cost basis of the repurchased stock, which will be $400 plus the amount you bought.
How Does the Wash Sale Rule Apply to Cryptocurrency Investment?
Different countries have specific rules affecting wash sales. How the rules are interpreted and the state of crypto regulation in the country determines how these rules affect crypto, which means wash sale rules apply to crypto differently.
The United States Internal Revenue Service currently considers cryptocurrencies as properties rather than securities. As a result, they are not affected by the wash sale rules. There are ongoing discussions about extending the rule to include cryptocurrencies, but they remain unsuccessful. Until such rules cover crypto, it may be safe to sell crypto at a loss and buy it back within 30 days and still be able to record the loss for tax purposes.
In Australia, you can't sell an asset at a loss and buy the same asset to gain a tax benefit at any time. The Australian Taxation Office (ATO) does not encourage wash sales, warning that taxpayers who engage in it are at risk of facing compliance actions and penalties. This rule also affects crypto in some way.
Understand Your Country's Tax Laws
Wash sale rules are sometimes not straightforward, and interpreting tax laws can be challenging. However, you must still try to understand the tax rules in your country or jurisdiction and how they apply to and affect your cryptocurrency investments.
Employing the service of a tax professional can help you identify potential wash sales and employ effective strategies for making the most of them or avoiding them completely, depending on your country's tax laws.