Do you trade Bitcoin and Ethereum? It’s a good idea to know about wash sales, constructive sales, and straddles.
The first part of the attack on cryptocurrencies is that the Internal Revenue Service is chasing tax evasion. This is a successful trader who neglected to pay taxes on profits. It includes threatening letters, obtaining customer records from exchanges, and undoubtedly plans to make a public example of a major criminal someday.
The second part of the crypto war is aimed at honest investors. The government wants to make it harder for you to claim losses and make it easier for you to be forced to declare profits.
Part II is most of the work in progress. The tax increase being discussed in Congress extends the rules for wash and constructive sales. These currently apply only to stocks, bonds, etc., and also to other investments such as commodities, currencies, digital assets, etc. This article defines these two tax targets and details the defenses.
Whether the Biden administration can conclude a vote for a tax increase aimed at raising $ 2 trillion in 10 years remains an open question. However, cryptocurrency crackdowns are very likely to find their way in the statutory sooner or later. This is because cryptocurrency players are perceived to be unjust enriched from existing tax laws.
Mark Fichtenbaum, a certified accountant, lawyer and professor at Pace University, said: [about the loopholes] In a magazine like you. In short, even Republicans may approve the crackdown, as they did in the recently inherited IRA. It’s rewarding to prepare to go tougher on your 1040.
The battle between Congressional tax writers and wise investors dates back a century, to section 1091 of tax law, the rules of the wash sale. The law says that if you buy back shares near the time of your loss sale, you cannot deduct the capital loss of the shares. More precisely, if you buy the exchange shares within 61 days from 30 days before the loss transaction, the loss will be suspended.
Example: Suppose you buy 100 Tesla for $ 800, see it drop to $ 600, and want to charge a capital loss of $ 20,000 while maintaining your exposure so you don’t miss a rebound. If you double your position and sell your original stock a week later, you will not be able to claim a loss. Instead, $ 20,000 will be added to the cost of the replacement stock. The effect is to leave you where you would have been if you were standing on the putt.
Under current law, wash sale rules do not apply to cryptocurrencies. And that means crypto investors can turn significant volatility in their markets into immediate tax gains. They can regularly book tax losses on recent purchases without actually changing their position.
Enjoy this feature of cryptography as much as possible. If you haven’t recovered your losses from your crypto portfolio yet, start now. The pending tax bill applies wash sale restrictions to transactions that occur after December 31, 2021.
Even after this law or other law comes into force, there are ways to capture losses while participating in market rebounds. Section 1091 states that there is a problem only if the replacement property is “substantially identical” to what is being sold at loss.
When is one investment effectively the same as another? It is not defined exactly. The IRS will probably argue that Bitcoin is virtually identical to Bitcoin exchange-traded funds. Therefore, it is not a good idea to sell Bitcoin at a loss and buy a Bitcoin ETF immediately. (Such funds are not yet registered in the United States, but can be found in Toronto.)
What if I use shares in the Grayscale Bitcoin Trust (GBTC over-the-counter market in the US) instead of coin stakes? This is not an ETF. It’s like a closed-end fund. The tax collector may or may not win here. It can be argued that owning a trust stock that has changed from a high premium that exceeds the value of the coin over the past year to a recent 15% discount is not the same as owning Bitcoin.
But you don’t have to bet on this unanswered legal question. There is another way to maintain a temporary interest in cryptography. For replacement real estate, purchase the Grayscale Digital Large Cap Fund (GDLC). The fund is clearly different from any of these coins, with 65% invested in Bitcoin and 28% invested in Ethereum. After 31 days, you can get rid of the fund and its solid 2.5% annual expenses and reestablish your Bitcoin position.
Now, these harvested losses are especially useful (and probably do) only if you have capital gains elsewhere in your investment life. They come with potential tax costs. The lower cost base of digital assets will result in higher profits for future reports. But that benefit can come in the next few years. Under current law, you can avoid recognizing the benefits of assets transferred or left behind in your property. The abolition of real estate giveaways, dubbed “basically step-up,” was part of the Biden tax system at one point, but is no longer included in the bill.
The dispute over trading tricks did not end with the Wash Sale Act. In 1997, Congress added code section 1259 on “constructive sales.” It is intended for investors who use short-term sales or hedging such as futures to fix their profits without selling their valued assets. The law requires hedgers to report profits and clear their throats immediately.
Section 1259 no longer applies to digital assets. Therefore, you can effectively monetize your winning Bitcoin bets without paying taxes. Professor Fichtenbaum’s Hypothesis: “You own $ 100 million in Bitcoin on a zero basis. Sell Bitcoin short. Borrow $ 99 million in cash for hedged positions. You have money. Buy whatever you want at and never pay taxes. When you die, there is basically a step up. “
Good, but don’t count on it. Short-cell games are probably destined for the same reasons that crypto wash sales can be nailed.
The IRS Anti-Trader Armory has a third weapon. It has to do with “straddles,” which are investments that make long and short bets on financial assets at the same time. In 1981 Congress added Section 1092. It states that if there is a pair of offset positions, the losing tax loss cannot be booked until the winning side is closed. Also, hedging cannot be used to convert short-term profits into long-term profits because the holding period of the winning position is suspended.
Section 1092 was originally aimed at rampant tax pranks, including Treasury bill futures, but is a radical law that covers all types of assets, including put options, and all types of hedging. It reaches cryptocurrencies even though it didn’t exist until 30 years after the law was enacted.
Traders of digital assets need to pay attention to straddle prevention rules. Some of the pitfalls are the combination of Bitcoin or Bitcoin fund positions and the opposite positions of Bitcoin futures (traded on the Chicago Mercantile Exchange), resulting in a terrifying mix called mixed straddles. The mix in question is related to the fact that coins are taxed in one direction (like stocks), while futures are taxed in another way (sold on December 31st, 60%). Is long-term and 40% is short-term). Special penalties for mixed straddle owners can be avoided, but they require complex tax planning.
How do you hedge in such an environment? By not making offsetting transactions. The IRS is Reg. 1.246-5 (c) (1) (iii) (B); If there is a 70% overlap, one portfolio offsets another. Its diversified grayscale fund does not overlap with either Bitcoin or Ethereum, but it does overlap with a portfolio that includes both. “Portfolio” in this context means everything you own.
One way to hedge a winning coin position is to take out indirect insurance against the decline …