How a Propose Wash Sale Rule Could Affect Crypto Traders

The massive infrastructure spending package proposed by the administration of United States President Joe Biden could create a significant budget deficit, and this is a risk that Democrats would like to prevent through certain rules and provisions that can be attacked to the bill. One of these measures is known as the "wash sale rule," and its proposal makes it clear that digital assets such as Bitcoin and other cryptocurrency tokens would be affected.

The Ways and Means Committee of the House of Representatives released a explanatory statement on this so-called wash sale rule, which on Wall Street represents a tax mitigation strategy related to losses incurred while trading. The section that corresponds to the proposal tendered by Democrats specifically mentions commodities and digital currencies.

A wash sale occurs when investors liquidate assets through straight sales transactions at a loss, but with the intention of acquiring pretty much the same assets within 30 days. The problem with this strategy is that it opens the door to what is known as tax harvesting, which some investors can use to reduce their liability with regard to other assets subject to capital gains tax.

While the proposal under the section does not remove the wash sale rule from cryptocurrency, it's far from clear how the other sections will affect cryptocurrency investors or whether there will be some form of taxation applied to cryptocurrency trades in the future. The question is a complicated one that seems to be one of many questions that Congress is pondering.

There is no surefire test to determine whether a transaction constitutes a wash sale. The U.S. Treasury Department has issued various advisory letters and other guidance to aid in the decision-making process. IRS filings from last year indicate that the agency had received questions from many of the nation's top law firms about how it would apply the proposed wash sale rules.

Some taxpayers use wash sale rules to take out an entire line of credit or get cash from a margin loan, so they could use the losses to wipe out their capital gains, the IRS said. Other taxpayers use wash sale rules to sell stock in small amounts to boost gains and then buy the same securities to offset those losses. The tax gain is wiped out, but any cash or margin loan used to buy the securities counts toward the annual gift and estate tax exemption.