Although the digital asset market has cooled as cryptocurrency prices have fallen, some investors have options to make the most out of crypto losses from a tax perspective, according to Baker Tilly Senior Manager, Washington National Tax, Kasey Pittman.
Pittman told Checkpoint in an interview that currently, cryptocurrency prices have hovered around “70% off of peak market cap” in November 2021. While some have profited from crypto investments in recent months due to the fluctuating and often volatile tendencies of the market, Pittman said “by and large, we’ve seen losses over the last 18 months.”
Collapses of several big-name crypto platforms like FTX—which Pittman described as the “largest” and “most significant”—have made many current investors and perhaps prospective first-time buyers gun-shy about chasing the proverbial crypto dragon. Pittman said there were “a myriad of factors that led to the downfall of FTX,” largely in part due to the unregulated nature of the industry. She added that tax professionals are awaiting legislation to add some protective guardrails for customers and “restore confidence” in the market, but noted the presently divided Congress.
One such pending bill that has not yet advanced is the Responsible Financial Innovation Act (S 4356). Introduced in June 2022 by Sens. Cynthia Lummis, a Wyoming Republican, and Kirsten Gillibrand, a New York Democrat, the bill purports to grant regulatory authority to the Commodity Futures Trading Commission, among other sweeping reforms to the tax treatment of digital assets.
Pittman is “very interested to see what even makes it to the floor,” but would not yet bet on any specific provision. “We have to see how it shakes out and if [Congress is] able to come up with a bipartisan compromise.”
As prices are down and legislation remains distant, Pittman offered tax considerations some taxpayers may wish to explore during this “crypto winter.”
For background, digital assets, including virtual currencies like crypto, are classified as property and have been since 2014 IRS guidance (Notice 2014-21). Only a set of FAQs have been released by the IRS on digital assets since. “At the time of their release, the guidelines left numerous important questions unanswered,” wrote Pittman and her Baker Tilly colleague Michelle Hobbs October 25 in an article on the firm’s website. “Additionally, in the intervening years, the digital asset market has drastically evolved and expanded, creating many new applications and types of transactions not covered by existing guidance.”
What we do know is that capital assets held for at least a year enjoy a lower capital gains tax rate compared to capital gains realized in the short term. “Capital losses can offset capital gains each year,” Pittman reminded taxpayers.
“If you have more losses than gains, you can use up to $3,000 of that loss to offset your ordinary income, like your wages. Anything more than $3,000 gets carried forward to next year.” She said harvesting losses is a “normal tax planning technique that tax advisors use regularly.”
Next, current law provides that when a security is sold at a loss, a taxpayer cannot purchase a “substantially identical” security within 30 days and claim that loss on their tax return. This is known as the “wash sale rule” under Code Sec. 1091. However, this does not apply to digital assets and thereby cryptocurrencies, as they are considered property and not securities. Thus, as Pittman explained, crypto holders can recognize a loss on their investment even if they immediately buy replacement crypto, which for many could be at a lower price now than the original asset.
President Biden’s fiscal 2024 budget revives the administration’s previous proposal to apply the wash sale rule to digital assets, that is, “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology.” An early provision of what eventually became the Inflation Reduction Act (PL 117-169), previously dubbed the Build Back Better plan, would have closed what the administration sees as a tax loophole. The budget’s accompanying Greenbook, in which the Treasury Department examines revenue-raising proposals, reads that the “same loss recognition rules should apply to digital assets held as investments or for trading as would apply for stocks and securities.”
Pittman described the Greenbook as a “wish list,” and would “put more stock in” a potentially revised wash sale rule if Democrats still controlled both chambers of Congress. “If you are looking for losses but want to stay in the market, [this is a] unique opportunity for the moment while there’s no law saying you can’t,” she said.
For more on the tax treatment of digital assets, see Checkpoint’s Federal Tax Update ¶I-2151.
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