Congress plans to close this crypto tax loophole

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Congress is currently planning big changes to the tax code to help raise money for President Biden’s $ 3.5 trillion social infrastructure spending plan. Among the changes to the House Ways and Means Committee proposal is a change to the wash sale rule to include cryptocurrencies.

The indirect sale rule prevents investors from selling and repurchasing a security in order to show a tax loss on the investment. The proposal extends this rule to “products, currencies and digital assets”.

Image source: Getty Images.

How the flaw works

Cryptocurrency investors who buy and hold assets like Bitcoin (CRYPTO: BTC) for the long term had a big opportunity earlier this year. When the price of Bitcoin fell from over $ 60,000 to under $ 30,000 over the summer, investors who bought Bitcoin as its price neared its all-time high could have sold their coins and sold them. redeem almost immediately.

This tactic still works even if you bought Bitcoin for less than its current trading price. The IRS allows you to specify the Bitcoin you are selling when you make a transaction. So, as long as you’ve bought Bitcoin above its current price, you can use this tactic to lower your taxes in the current year.

The only caveat about executing these transactions is that you must show that they had “economic substance”. In other words, there was a risk of loss for the investor by selling and redeeming moments later. Given the volatility of cryptocurrency and the high costs of trading compared to securities, this burden is easy to prove.

When you sell Bitcoin or any other cryptocurrency for less than what you paid, you can claim a capital loss in the year of the transaction. This loss can offset any capital gain in the same year. If you don’t have enough capital gains to offset, you can offset up to $ 3,000 of ordinary income per year. And if you have more losses than that, you can carry the loss over to future years until the loss is exhausted.

It is important to note that harvesting a capital loss will permanently reduce your base cost. When you sell in the future, you will need to use your new, lower cost base to calculate your capital gains and pay taxes on that amount. In other words, you are reducing your tax payable this year, but increasing it in the future. This is a good deal for most investors, especially if they are able to offset ordinary income, which typically has higher tax rates than capital gains.

Why is Congress closing the loophole?

Congress is trying to increase tax revenue for Biden’s $ 3.5 trillion social infrastructure plan. Harvesting tax losses reduces tax revenue in the present even though it potentially offsets this tax cut in the future when investors actually sell.

The wider adoption of the cryptocurrency in late 2020 and early 2021 as well as the massive price drop this summer have highlighted the loophole. It is likely that many large investors took advantage of the opportunity, and they could benefit from the carry-over of losses for years to come. But Congress needs the money now.

Additionally, it is evident that Bitcoin and other digital currencies trade much more like securities than most other forms of property. Most importantly, they are fungible. A Bitcoin at this address is worth the same as a Bitcoin at this address.

The same cannot be said of most other goods, especially non-digital goods that have a fitness component. As such, investors can be happy to sell their Bitcoin and receive another Bitcoin later.

Based on these facts, I would argue that cryptocurrency should in no way be treated like other property for tax purposes, regardless of Congress’ need for short-term fundraising.

It may still be possible for you to profit from the way cryptocurrency is currently taxed, but investors should expect the loophole to close in the near future as Congress makes changes to the. Tax Code.

This article represents the opinion of the writer, who may disagree with the official recommendation position of a premium Motley Fool consulting service. Were motley! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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