We think it’s clear by now that the prices of cryptocurrencies like Bitcoin can have major swings.
It wasn’t too long ago that Bitcoin and other coins dropped over 30% and caused quite a panic.
But instead of panicking during big price drops, what if we told you that you could actually use these swings to your advantage?
That’s right! While everything is on fire, you can actually leverage losses in crypto in ways that even your typical stock investors cannot.
All it takes to use this cryptocurrency tax loophole is a click of a button and it works for all cryptocurrencies at the moment. It’s so easy, a caveman can do it.
Our goal for today’s post is to explain the cryptocurrency tax loophole in an easy-to-understand manner, so you can benefit from it.
Let’s dive in.
A quick disclaimer that this is not financial or legal advice, and you should consult with your personal CPA or lawyer regarding your specific situation.
Quick Cryptocurrency Story
So let’s go back in time to set the scene to help us understand.
It’s mid-April 2021 and Bitcoin just blew past $60,000 to reach all-time highs.
Your co-worker is talking about Bitcoin…
The guy at the gas station is talking about Bitcoin…
Heck, even your mom is talking about that Bitcoin thing she heard about on the news.
You’re feeling like the momentum can’t be stopped so you buy in at the peak around $65,000.
Then late May arrives, Bitcoin suddenly plummets to under 30k – you’ve lost more than 50% of your investment in less than a month.
You find yourself stuck staring at your Robinhood account with two choices:
- you can sell now to make the pain stop, or
- you can hold knowing the future is uncertain.
Bitcoin enthusiasts would tell you to hold because it is going back up to $100,000.
Others would tell you to sell because Bitcoin is going to 0.
Which one do you choose?
How the IRS Views Cryptocurrency
Well, here’s where understanding the cryptocurrency tax loophole comes into play.
The key to the loophole can be found in how the IRS currently views cryptocurrency.
Which luckily for crypto traders, is completely different from how the IRS views stocks.
The IRS views cryptocurrencies as “property” unlike stocks which are viewed as “security.”
Because cryptocurrencies are treated as “property” and not as a security, the IRS wash sales rule, which is applicable to stocks, is not applicable to crypto.
What is the Wash Sale Rule?
The wash sale rule for securities states that stock investors aren’t allowed to sell a security for a loss and buy the same or substantially similar security 30 days before or 30 days after the sale.
Because if they do, they will incur penalties.
So, in short, the classification of cryptocurrency as “property” along with the wash sales rule not being applicable to cryptocurrency trades opens the door for the loophole.
The Cryptocurrency Tax Loophole
This means crypto traders can sell for a loss at any time, use that loss to reduce any capital gains on other investments, and immediately buy back the crypto to capture unrealized gains.
This is a huge hidden loophole when you consider the huge swing in prices for cryptocurrency.
For example, take a look at this chart that shows Bitcoin’s 10 biggest one-day drops.
Let’s use our example from earlier.
Say you decided to sell your Bitcoin during the crash for $28,000 that you bought at mid-April highs for $62,000 incurring a $32,000 loss.
Let’s also say that you sold some stock this year for a 32,000 gain.
The Bitcoin loss would eliminate the taxes you would have to pay on your gain AND you would have the ability to buy right back in and avoid triggering a wash sale
In this scenario, you can have your cake and eat it too.
You can sell on the big drops to reduce your taxes for the year and immediately buy back in for the spike back up.
If you are like us and love saving on taxes, you are loving this right now.
Now, as good as it all sounds, there are some caveats to the loophole that we want to go over with you.
Caveat #1: The loophole may not last forever.
The IRS and the SEC may at some point make the claim that cryptocurrencies are in fact not “property” but “securities.”
In fact, the new head of the SEC recently said that more “regulation” is needed and hinted at the fact that he views some crypto tokens as securities.
So, if there was a time to use the loophole, it would be, well, while you still can.
Caveat #2: The loophole only works for actual cryptocurrencies like Dodge and Bitcoin.
If you invest in actual crypto-related securities like Coinbase or Voyager, they are considered securities and the wash sale rule applies to them.
Caveat #3: The IRS may negate the loophole if you sell and buy back too quickly.
The IRS doesn’t really approve of people trying to game the system and would like investors to bear some risk for their trades.
Selling and buying back a second later doesn’t really look legitimate. Instead, buy back at least 24 hours as a formality to help protect yourself.
Well, there you have it! A complete breakdown of the cryptocurrency tax loophole that no one is talking about.
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