Crypto taxes are back in the news. On Tuesday, President Joe Biden tweeted an infographic suggesting that Congress should eliminate “tax loopholes that help rich ($18 billion) crypto investors.”
The language had some in the industry scratching their heads: What is the $18 billion loophole?
The White House did not clarify where the dollar figure came from, but it is likely related to the collection of tax losses in combination with laundering sales.
You’ve probably taken tax losses and don’t even know you’ve done it. It’s a simple concept: sell underperforming or losing assets, such as stocks that have plummeted in value, to create losses that offset gains on appreciating assets. Selling stocks or other investments that are losers to offset the gains of the winners is known as harvesting.
The rules can be tricky, but losses are often used to offset gains of the same type (short-term gains against short-term losses, long-term gains against long-term losses). But if one type of loss exceeds your gain of the same type, you can apply them to the other type. And if your capital losses for the year exceed your capital gains, you can deduct up to $3,000 in net losses from your total annual income. Beyond that, you can carry over losses to subsequent tax years.
For tax purposes, a wash sale Occurs when you sell or trade shares or securities at a loss and then, within 30 days before or after the sale, buy or acquire substantially identical shares or securities.
A substantially identical stock or security is exactly what it sounds like. You have a fictitious sale when you sell shares of a stock or security and then buy the exact same stock or security. You can also end up with a fictitious sale if you sell shares or securities and buy shares or securities of a related company, including predecessor or successor companies in a reorganization. The fictitious sale rules also apply to losses from sales or exchanges of contracts and options to purchase or sell shares or securities. Generally, the IRS looks at the facts and circumstances when determining whether a stock or security is “substantially identical.”
Why does that matter? Most taxpayers cannot deduct losses from sales or exchanges of stock in a fictitious sale, making any tax collection involving a fictitious sale worthless in that tax year. While you lose the deduction, it’s not all bad: you can add the amount of the loss to the cost basis of the replacement shares or securities, which could be beneficial in the future.
No Wash Sales For Crypto
The wash sale rules do not apply to all assets. For example, they do not apply to losses on sales or transactions of commodity or currency futures contracts. And, in particular, they do not apply to digital assets. That’s because digital assets, including cryptocurrencies, don’t meet the definition of a share or security in the statute or Reg..
You can already see where this is going. If you can offset the gains with the losses, that can be a tax advantage. And, without pesky wash-sell rules, if you have an asset that loses, you can sell it at a low point to take advantage of the loss and buy it back.
That could change. from President Biden proposed budget for fiscal year 2024 it includes a proposal to make digital assets subject to wash-sale rules, with the goal of “closing a loophole that benefits wealthy crypto investors.”
Specifically, the proposal it would require that “the same loss recognition rules be applied to digital assets held as investments or for trading that would be applied to stocks and securities.” The term “digital asset” would generally mean “any digital representation of value that is recorded in a distributed ledger with cryptographic security or any similar technology as specified by the Secretary.”
If you feel like you’ve heard that before, you’re not wrong. He Initial Bill of the Build Back Better Act of 2021 it included similar provisions that were not included in the replacement Inflation Reduction Act.
The rule, if signed into law, would go into effect in 2024. The administration estimates the change would generate $1.24 billion in 2024 and $8.97 billion over the next five years. Between 2024 and 2033, the estimated increase in revenue is $23.52 billion.
(The budget also includes a premium for energy consumption used in crypto mining. You can read more about that here.)
The $18 Billion Question
That’s still not $18 billion. So where does it come from?
TO 2022 National Bureau of Economic Research (NBER) Working Paper found that increased scrutiny of cryptocurrencies has made markets move faster. Specifically, they found that “domestic merchants in particular increase tax loss collection following increased tax scrutiny, and US stock markets exhibit significantly more laundering trades.” This is because, as noted above, it is easy to download crypto, take a loss (used to offset gains), and then quickly buy it back.
As for the 2018 tax year, with an assumed tax rate of 30%, the authors of the article estimated that the loss of tax revenue due to the absence of fictitious sale rules ranges from $10.02 to $16.2 billion. Of course, there was no 30% rate in the US In 2018, as now, the tax rates were 0%, 12%, 22%, 24%, 32%, 35%, and 37%, but it was gets the point.
The models are great, but I don’t know if anyone can say for sure how much revenue could be generated by subjecting cryptocurrency sales to wash-sell rules, though I think we can all agree that it would be significant.
An even bigger question? If the proposal goes through the current Congress. That remains to be seen.