Key takeaways
- A wash sale occurs when an investment position is quickly reestablished
- Wash sales can be triggered in inadvertent and surprising ways
- Wash sale rules apply to securities but still matter for crypto investors
“It’s a wash” is an idiomatic English expression referring to a result that is generally neutral. Wash sales, important for traders and investors, are transactions that neutralize or negate recorded losses. If you’ve heard anything about wash sales, then you probably know already that it’s smart to avoid them.
Understanding wash sales is crucial for every type of investor including crypto investors. Want nine ways to prevent them? Keep reading to get your head around crypto wash sales.
What is a cryptocurrency wash sale?
A crypto wash sale occurs when an investor sells a cryptocurrency at a loss and then repurchases the same or a substantially identical cryptocurrency within a defined period of time—typically 30 days. The investor is prohibited from claiming the capital loss from the sale as a tax deduction because she has essentially reestablished her position.
Crypto wash sales can occur in several different ways:
- Transacting in close temporal proximity: Reestablishing a cryptocurrency position within 30 days is the most direct way that a wash sale can occur.
- Transacting in substantially identical tokens: A crypto investor may trigger a wash sale by transacting in similar or identical digital tokens. Stablecoins pegged to the same fiat currency, tokens representing the same underlying asset, and variants of the same blockchain can potentially be considered as substantially identical.
- Transacting across accounts: Wash sale rules apply to all of an investor’s accounts. An investor may inadvertently trigger a wash sale with transactions completed in different accounts.
Avoiding wash sales as a cryptocurrency trader or investor is a smart move, although it’s important to note that digital assets in 2023 are exempt from IRS wash sale rules. The Internal Revenue Service treats digital assets as property, and currently applies wash sale rules only to securities. Congressional lawmakers are actively working on legislation that would enforce the wash sale rule for crypto assets.
How do cryptocurrency wash sales work?
Let’s examine the series of events that creates a crypto wash sale to understand exactly how wash sales work.
1. Buy ABC crypto: Imagine that you purchase 100 ABC tokens for $2 each, spending $200.
2. Sell ABC crypto: At a later date, you sell the 100 ABC tokens for $1.50 each, receiving $150.
3. Record a capital loss: You record a capital loss of $50 based on the difference between the purchase and sale prices.
4. Buy ABC crypto again: Within 30 days of selling your ABC tokens, you buy 100 ABC tokens again. Reestablishing your ABC position negates the capital loss that you recorded after the sale.
9 strategies to avoid crypto wash sales
Nobody likes triggering a wash sale. Keep reading to get nine solid strategies for avoiding wash sales with your crypto assets.
1. Understand the 30-day rule
Understanding and staying cognizant of the 30-day rule for wash sales is the cornerstone of avoiding wash sales in your trading and investment accounts. You’re reading this blog, so—clearly—you’re already ahead of the game.
2. Document all crypto transactions
Diligently documenting all of your crypto transactions is another strategy that can help traders and investors to avoid triggering wash sales. Record transaction dates, amounts, and other pertinent information.
3. Create a reminder system
You can establish a calendar-based reminder or alert system to ensure that you don’t transact in a way that violates the wash sale 30-day rule. Active traders may especially benefit from using a reminder system.
4. Review your crypto transactions in all accounts
If you’re transacting in digital assets and control multiple accounts, then tracking all of your transactions across all accounts is important to not inadvertently trigger a wash sale. The accounts that you track should include all personal accounts and any accounts that you jointly own.
5. Diversify your crypto portfolio
Using the proceeds from a crypto sale to buy a different digital or traditional asset can enable you to easily avoid a wash sale. The rules for wash sales only apply if you repurchase an asset that is the same or substantially identical.
6. Avoid automated reinvestment
Configuring your crypto portfolio to automatically reinvest capital gains or dividends can trigger wash sales. Automated reinvestment should be carefully monitored or avoided altogether.
7. Harvest crypto tax losses carefully
Anyone can sell underperforming crypto assets to recognize a capital loss. While this type of transaction may enable you to harvest tax losses, it could also trigger a wash sale if you reinvest the proceeds in the same or substantially identical tokens within 30 days. Pay close attention to wash sale rules if you’re pursuing a tax loss harvesting strategy.
8. Consult with a financial advisor
Another strategy to avoid triggering wash sales is to consult with a financial advisor for professional advice. If you’re an active crypto trader with a diverse portfolio, then getting professional help may be a smart move.
9. Pay attention to changing crypto regulations
Tax laws and regulations that govern digital assets are rapidly evolving. Investors and traders who monitor the regulatory landscape are well positioned to learn about any new wash sale rules before they take effect.
How to learn more about cryptocurrency wash sales
If you’re motivated to learn more about cryptocurrency wash sales, then you have plenty of ways to gather more information. Here are some ways that you can continue learning:
- Visit tax authority websites
- Read tax and finance blogs supported by credible sources
- Read books about investment taxation
- Consult with a crypto tax professional
- Enroll in online investing and taxation courses
- Participate in investment communities and forums
- Explore wash sale tutorials for financial software
- Subscribe to credible tax and finance newsletters
Understanding wash sales and how they apply to cryptocurrency is your first major step toward not triggering one in your digital assets portfolio—so you’re already moving in the right direction. If triggering a wash sale is a concern or even a possibility, then your next step is to make the necessary adjustments to mitigate your risk.
