U.S. investors can deduct from their capital gains tax this year by selling cryptocurrencies at a loss, then immediately buy back those same assets. The opportunity stems from a regulatory distinction crypto has, versus other financial assets such as securities, a tax expert told Forkast

According to the U.S. Internal Revenue Service (IRS), investors in the U.S. who sold assets for a net loss at the end of the tax year can reduce their capital gains tax by up to US$3,000, with additional losses carried forward to the following year. 

This is a common strategy used by investors, especially in years with significant financial losses in major markets, said Benjamin Goldburd, tax lawyer at Goldburd McCone LL in New York City, to Forkast in an interview.  

However, an IRS policy called the “wash rule” prevents investors from selling certain assets to take advantage of the tax deduction, then buying them back within 30 days of the original sale. But for crypto investors, this rule does not currently apply, said Goldburd. 

“Cryptocurrency is not considered a security for IRS purposes, for the time being, it’s considered an asset, and thus the heavy aspects of tax law don’t apply to it, including the wash sale rule,” he said. 

As a result, an investor can sell crypto at a loss and buy it back within seconds while still registering it as a loss in their tax forms, added Goldburd. 

Leaving the “wash sale” door open could be much welcomed relief to crypto investors looking to offset losses while keeping their assets headed into the new year. Bitcoin, the largest cryptocurrency by market capitalization, has lost over 60% in value since January 2020. 

However, Goldburd warned of risks associated with the strategy. 

“From a trading aspect, you have to know what you’re doing, so it’s not necessarily for crypto novices… The IRS has also been silent on the matter, so while crypto is not designated a security from a tax perspective, there’s always the chance the IRS could put up a fight on this matter, and they just haven’t yet.” 

The IRS last discussed crypto in October, when it defined a “digital asset” tax category that included cryptocurrencies, stablecoins, and NFTs. According to the agency, digital assets should be treated as property for federal tax purposes. 

But regulators have started to diverge on crypto’s classification as an asset, after it emerged as a mainstream investment class. 

The Digital Commodities Consumer Protection Act introduced to the Senate in August would regulate digital assets as commodities under the Commodities Futures Trading Commission. The Securities Trading Commission (SEC) has also asserted its authority over the space in recent years, filing charges against multiple crypto companies for the “unregistered sale of securities.”

Goldburd expects that the trial of Sam Bankman-Fried, the founder of bankrupt cryptocurrency exchange FTX, could affect regulators’ stance on digital assets. Bankman-Fried stands accused of committing one of the largest financial frauds in American history and defrauding his customers of billions of dollars.  

International business news site Quartz previously reported that FTX utilized wash sales and tax loss harvesting as a tax avoidance strategy. 

American software company MicroStrategy, the largest corporate holder of Bitcoin reserves, has seemingly also moved to take advantage of crypto tax loss harvesting. 

The company disclosed on Wednesday that on Dec. 22, it sold over US$11 million of its Bitcoin holdings for the first time ever. Then, the company owned by Michael Saylor repurchased even more Bitcoin. 

“MicroStrategy plans to carry back the capital losses resulting from this transaction against previous capital gains, to the extent such carrybacks are available under the federal income tax laws currently in effect, which may generate a tax benefit,” the company wrote in a filing with the SEC.

According to reports, the Senate Finance Committee earlier this month mulled closing the tax-loss harvesting opportunity through crypto wash sales. 

The report said that defining crypto as securities under the IRS was put forward to increase tax revenue and offset the spending on a US$1.3 billion wildlife conservation legislation. However, the bill has not progressed, with or without a crypto wash sale provision. 

Closing the crypto wash sale loophole had also been part of an early version of U.S. President Joe Biden’s trademark Build Back Better Act, but was dropped before the legislation passed the Senate. 

The U.S. Congress’s Joint Committee on Taxation estimated that subjecting crypto to wash sale rules would raise US$16.8 billion over the next decade. 

A spokesperson for the Senate Finance Committee did not respond to an email from Forkast News as of time of publication.

While some tax paperwork in the U.S. can be done up to the tax filing deadline on Apr. 18, there is no such grace period for tax-loss harvesting. Investors must complete all tax-loss harvesting paperwork before the end of the calendar year, on Dec. 31.