Crypto traders have short window to avoid house tax plan

The tax and spending package proposed by House Democrats would subject digital assets to two anti-abuse rules that already apply to stocks and other securities. The change would restrict the tools that crypto investors can currently use to protect themselves against potential losses and reduce their capital gains taxes.

A provision applying "constructive sale" rules to digital assets would take effect as soon as the bill is enacted. The rules would take effect when investors take offsetting short and long positions in an asset to reduce the risk of losing money. If compensating positions were taken, they would have to pay capital gains tax on the long position as if it were sold, even if it wasn't.

Cryptocurrency investors would also have to worry about "wash sale" rules starting in 2022. Those rules prohibit investors from claiming a deduction when selling an asset at a loss if they buy a "substantially identical" asset within 30 days. before or after the sale. .

The new rules for digital assets are part of a series of tax code changes that Democrats seek to implement quickly, leaving individuals and corporations with little time to react. But there is at least a small window, which is more than what investors got in 1997 when the constructive selling rules were first enacted retroactively.

Crypto investors with offsetting positions will want to consider liquidating both positions or at least selling one to avoid being hit by capital gains taxes under constructive selling rules, said Shehan Chandrasekera, head of tax strategy at CoinTracker, a company that helps people to manage and calculate. taxes on your cryptocurrency transactions.

Investors hoping to capitalize on tax savings before the wash sale rules take effect will have two months to "aggressively reap tax losses," Chandrasekera said, referring to the strategy of selling crypto assets at a loss and then buying them back. at a lower price. to reduce taxes on future capital gains.

However, investors will need to exercise caution when transacting late this year and into next, said Lisa Zarlenga, a partner at Steptoe & Johnson LLP who advises clients on issues related to blockchain and digital assets. Selling a cryptocurrency asset at a loss in early January can inadvertently trigger the wash sale rules if an investor bought a nearly identical asset less than 30 days earlier in December, he noted.

Congressional tax accountant, the Joint Tax Committee, estimated Thursday that changes to the constructive sale and laundry sale rules would collectively bring in about $ 16.8 billion over 10 years.

'Massive impact'

The House could vote on its reconciliation package as early as Friday after making some last minute changes. That would prepare the bill for the Senate, which is expected to make changes before approval.

The provisions on wash sales and constructive sales are similar to those included in a proposal presented by the Ways and Means Committee in September. They are separate from the reporting requirements that would be imposed on cryptocurrency brokers, such as exchanges, under the Senate-approved bipartisan infrastructure deal that the House could also consider on Friday.

Once the provisions go into effect, assuming they remain in the final reconciliation package, it would be "very, very difficult" for cryptocurrency investors and their financial advisers to comply with the rules, Chandrasekera said, noting the key characteristics that set the company apart. the cryptocurrencies of others. financial assets.

Cryptocurrency transactions occur more frequently than those involving stocks and other securities and often across multiple wallets and exchanges, making them more difficult to track, he said. CoinTracker has found that the average person has three to five wallets and exchanges. Additionally, there are platforms that have made it easier for the average person to engage in complex financial transactions, such as shorting, with their digital assets, Chandrasekera said.

The House bill would also expand the rules for selling currency laundering and commodities, but Zarlenga predicted there would be a "huge impact" on digital assets.

He noted that the bill would provide an exception for certain business transactions that involve sales of currencies or commodities, but not digital assets.

There is also an increased risk that the wash sales rules will be inadvertently triggered by exchanges of "gateway" currencies, such as Bitcoin or Ethereum, which are bought and sold much more frequently than others, Zarlenga said. A user could convert Ethereum, for example, to the native token of a decentralized financial platform to gain access to that platform.

"There will be so many transactions and it will be very difficult to potentially monitor," he said.

Official orientation

Many of the key industry questions about the proposed legislative changes would not be answered until the IRS and the Treasury Department published guidance on interpreting the law.

It is not clear in the legislation how "substantially identical" will be defined under the washing sale rules, Zarlenga said. Some may assume that an investor would have to buy and sell the same cryptocurrency, such as Bitcoin, but it is possible that the definition could be broader, he said.

Coinbase, the largest US-based cryptocurrency exchange, said it would pressure the Treasury and the Internal Revenue Service to adopt "sensible and personalized" regulations for cryptocurrencies.

"As more and more Americans embrace digital assets, these rules should not be too broad to stifle innovation or impose unworkable requirements on citizens," the company said in a statement.