Democrats want to close this crypto tax loophole. What it means for your portfolio

Published Sun, Oct 3 20218:02 AM EDT

Some cryptocurrency investors have been startled by recent volatility , while others are leveraging digital currency price dips to score a tax write-off while they still can. Currently, cryptocurrency isn't subject to so-called wash-sale rules , which prevent someone from selling a losing investment, deducting the loss against gains and then rebuying a "substantially identical" asset within 30 days. For example, someone who bought bitcoin for $50,000 may sell when it drops to $42,000, using the $8,000 loss to help offset other capital gains taxes. Then they may immediately buy back the same asset, possibly benefiting from the upswing if the price rebounds. "It's been one of the novelties of an asset class that is highly volatile," said Tyrone Ross, CEO of Onramp Invest, which provides cryptocurrency management technology for financial advisors. However, House Democrats want to close this loophole to help raise funds for their $3.5 trillion spending package . If enacted, the measure would require cryptocurrency to follow the same wash-sale guidelines as stocks, bonds and other securities. The proposal, effective for sales after Dec. 31, 2021, is already prompting some investors to rack up digital currency losses ahead of the deadline. "I see a lot of people taking advantage of this, especially considering the current market conditions," said Shehan Chandrasekera, a CPA and head of tax strategy at cryptocurrency tax software company CoinTracker.io. Timing digital currency Many are eager to cash in on the loophole before the year ends, but buying and selling digital assets at the right time can be tricky. "If you can't time the stock market, then you sure as hell can't time digital assets," said certified financial planner Ivory Johnson , founder of Delancey Wealth Management in Washington. While there may be some correlation between similar types of digital currency, the coins typically don't mirror more traditional assets, he said. Substantially identical assets If the proposal goes through, there will be questions about the definition of substantially identical assets, said Chandrasekera, as many investors want to keep using their current strategy. Tax-loss harvesting tactics after Dec. 31, 2021, may depend on how the IRS defines each asset, he said, and timing may require more scrutiny. His clients often ask if assets are substantially identical, such as bitcoin and wrapped bitcoin, which brings the virtual currency to the ethereum blockchain for lending and other purposes. Another scenario may be someone selling bitcoin and then buying shares of Grayscale Bitcoin Trust shortly after, Chandrasekera said. Some investors may try to argue the assets are different enough to skirt the rule.

Nicolas Economou | NurPhoto | Getty Images

Some cryptocurrency investors have been startled by recent volatility, while others are leveraging digital currency price dips to score a tax write-off while they still can.