What is a wash sale and how does it apply to crypto?

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Investing in cryptocurrencies has become increasingly popular among investors around the world. However, with the rise of this new asset class, tax laws have also evolved to cover investment activities related to cryptocurrencies. Therefore, every crypto investor should be aware of the tax regulations and their implications on their investment activities.

One of the ways investors try to take advantage of tax opportunities is to reap tax losses. However, in doing so, they should also be aware of 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 buy back the same asset or a substantially identical asset within 61 days, 30 days before and after the sale of the asset. Taxpayers make fictitious sales to reduce the total amount payable on account of tax.

To limit how traders use wash sales to claim tax benefits, the U.S. Internal Revenue Service (IRS) has put in place wash sale rules that prevent taxpayers from selling their securities at a loss and redeem them within 30 days before and after their sale.

How does a wash sale work?

Investors make wash sales as part of their tax loss collection strategy to reduce their overall tax liability. When realizing tax loss harvest, 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. This allows investors to reduce the amount they have to pay as tax.

For example, let’s say you buy 20 shares of a company at a rate of $200 per share, and the stock price drops to $180. If you sell the asset, you will realize a loss of $400. It is a wash sale if you buy the same or substantially similar asset again within 30 days before and after the sale.

By implication, you will not be able to claim the $400 loss on your tax return. Since the loss is already considered washed out, you cannot use it to offset gains for that tax year. The loss is instead added to the base cost of the redeemed stock, which will be $400 plus the amount you bought.

How does the wash sell rule apply to cryptocurrency investing?

Different countries have specific rules affecting wash sales. How the rules are interpreted and the state of crypto regulation in the country determines how those rules affect crypto, meaning wash sale rules apply differently to crypto.

The United States Internal Revenue Service currently considers cryptocurrencies to be property rather than securities. Accordingly, they are not affected by the wash sale rules. Discussions are ongoing about extending the rule to include cryptocurrencies, but they remain unsuccessful. Until these rules cover crypto, it can be safe to sell crypto at a loss and buy it back within 30 days while still being able to record the loss for tax purposes.

In Australia, you cannot sell an asset at a loss and buy the same asset for a tax benefit at any time. The Australian Taxation Office (ATO) does not encourage sham selling, warning that taxpayers who engage in it risk compliance action and penalties. This rule also affects cryptography in some way.

Understand your country’s tax laws

The rules of wash sale are sometimes not straightforward and the interpretation of tax laws can be difficult. However, you should always try to understand the tax rules of your country or jurisdiction and how they apply and affect your cryptocurrency investments.

Hiring the services of a tax professional can help you identify potential wash sales and employ effective strategies to make the most of them or avoid them altogether, depending on your country’s tax laws.

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