Bitcoin crash opens door to a tax loophole for investors

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Crypto investors may be shell-shocked by a recent plunge in prices. But that sell-off has a silver lining: It opens the door to a money-saving tax strategy.

Popular cryptocurrencies like bitcoin and ethereum shed more than half their value in volatile trading over the past month or so.

A bitcoin investor who bought at the mid-April peak (around $65,000) and sold low on Wednesday (near $30,000) would have lost 54%, for example.

But crypto losses are treated differently from those of stocks and mutual funds. That’s because so-called “wash sale” rules don’t apply, according to financial advisors.

This offers two benefits to crypto investors: They can sell crypto for a loss, and then use that loss to reduce or eliminate capital-gains tax on winning investments. Then, they can quickly buy back the crypto they sold so as not to miss out on a subsequent rebound in price.

The first benefit (called “tax-loss harvesting“) is allowed for stocks and other securities. However, the second benefit isn’t — stock investors aren’t allowed to buy the same or similar security within 30 days before or 30 days after a sale without triggering penalties.

“This is a loophole, so to speak,” Ivory Johnson, a certified financial planner and founder of Delancey Wealth Management in Washington, said of crypto relative to tax rules. “It’s heads I win, tails you lose.”

Crypto tax benefit

The so-called loophole exists due to the fact that regulators don’t consider cryptocurrencies to be “securities.” Instead, the IRS taxes them as property, Johnson said.

The tax treatment could make a big difference for an asset as volatile as cryptocurrency has been in recent weeks, according to financial advisors.

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Let’s take the example of a bitcoin investor who bought high and sold low, incurring a $35,000 loss. This year, the same person also sells stocks and mutual funds for a $35,000 gain. The bitcoin loss would erase taxes on the capital gains.

Further, this same investor could have quickly re-bought bitcoin near its $30,000 low and participate in any run-up. Its price jumped more than 10% Monday. Some bitcoin bulls expect the asset to reach $100,000 by year-end.

By comparison, a stock investor would miss out on 30 days of potential gains after a sale due to the wash-sale rules.

“It lets you completely manipulate [crypto] on the downside and use it to create a tax [benefit],” said Leon LaBrecque, a CFP and accountant at Sequoia Financial Group in Troy, Michigan.

Importantly, while this tax benefit applies to cryptocurrencies like bitcoin, ethereum and dogecoin, it wouldn’t for investors in crypto-related securities.

“You couldn’t dodge the wash with [crypto platform] Coinbase,” LaBrecque said. “But you clearly could dodge the wash with crypto.”

Caveats

The IRS essentially wants an investor to bear some economic risk for the sale — meaning some risk of loss, Levine said.

Investors who hit the bitcoin sell button and buy it back a second later risk the IRS negating the tax benefit. But the timing isn’t black-and-white.

“Time is always your best argument,” Levine said. “But given the volatility, and the fact it’s constantly trading, I think you have much more flexibility with crypto than you do with anything else.

“A day is more than sufficient,” he added. “I’d feel comfortable defending that to the IRS.”