House Democrats recently released details of their eagerly-awaited tax increase proposal and one of the many provisions calls for the application of the wash-sale rule to cryptocurrency.
What’s the wash-sale rule and what would this provision mean for buyers and sellers of cryptocurrency if it becomes the law of the land on Jan. 1, 2022?
According to the Securities & Exchange Commission, a wash sale occurs when you sell or trade securities at a loss and within 30 days before or after the sale you:
- Buy substantially identical securities,
- Acquire substantially identical securities in a fully-taxable trade, or
- Acquire a contract or option to buy substantially identical securities.
Internal Revenue Service rules prohibit you from deducting losses related to wash sales. For more information about wash sales, read IRS Publication 550, Investment Income and Expenses (including capital gains and losses).
“The application of the wash-sale rules to cryptocurrency would be one more obstacle to its widespread use as a practical medium of exchange,” said Jean-Luc Bourdon, a wealth adviser with Lucent Wealth Planning. “By definition, a currency must be generally accepted or in use, so I think this also undermines the long-term value of many types of cryptocurrencies.”
Other experts note that it will be difficult for cryptocurrency investors to keep track of their purchases and sales and avoid violating the wash-sale rule. For one, coins and tokens are purchased on centralized and decentralized platforms that don’t keep track of the purchase and sale of assets as do brokerage and mutual fund firms.
That means buyers and sellers of cryptocurrency will have to keep track of their basis and adjustments, according to Shehan Chandrasekera, a CPA and expert on cryptocurrency taxes.
How investors will go about that is an entirely different matter, though.
“It will be virtually impossible to account for wash sales and constructive sales in addition to regular trades, specific identification and valuation on Excel,” said Chandrasekera. “You will have to use a tool like CoinTracker to track your crypto activity and produce accurate tax reports.”
As the year winds down, those looking to trim their tax bill may consider an individual retirement account contribution. Before transferring the funds, however, there are rules and limits investors need to know, financial experts say.
“Anyone can contribute to a traditional IRA — you, me, Jeff Bezos,” said certified financial planner Howard Pressman, partner at Egan, Berger & Weiner in Vienna, Virginia.
However, the ability to write off IRA contributions depends on two factors: participation in workplace retirement plans and income.
For 2021, someone may deposit up to $6,000 into their IRA ($7,000 for someone age 50 or older), provided they have earned that much income, anytime before the tax-filing deadline.
An investor and their spouse may be “in the clear” to write off their entire IRA contributions if both spouses aren’t participating in an employer’s retirement plan, said Larry Harris, CFP and director of tax services at Parsec Financial in Asheville, North Carolina.
However, the rules change if either partner has coverage and participates in the plan, including deposits from the employee or company.
For example, participation may include employee contributions, company matches, profit sharing or other employer deposits.
IRA deduction limits and phaseouts
Single investors using a workplace retirement plan may claim a tax break for their entire IRA contribution if their modified adjusted gross income is $66,000 or less.
While there’s still a partial deduction before they reach $76,000, the benefit disappears once they meet that threshold.
Married couples filing together may receive the full benefit with $105,000 or less, and their partial tax break is still available before reaching $125,000.
There’s an IRS chart covering each of these limits here.
Spouses who don’t work outside of the home may also contribute based on the income of the earning spouse, in what’s known as a spousal IRA, Pressman added.
“This also has income limitations, but they are higher than those for workers covered by a plan,” he said.
Options if you can’t deduct
While some investors won’t qualify for IRA contribution deductions, there are other options to consider.
Non-deductible IRA contributions are a popular choice because some investors may qualify to convert the after-tax deposit to a Roth IRA, known as a “backdoor” maneuver, bypassing the income limits.
However, the tactic may be on the chopping block.
House Democrats want to crack down on the strategy, regardless of income level, after Dec. 31, according to a summary released by the House Ways and Means Committee.
But with the budget in flux, it’s unclear if the provision will make it through negotiations.
Other options may include maxing out a workplace retirement plan, including catch-up contributions for those who are age 50 and older, Pressman suggests.
After that, someone may consider investing in low turnover index mutual funds in a regular brokerage account.
“This account will not be subject to retirement rules, limiting your access to the funds, and when you take distributions your growth will be taxed at more favorable capital gains tax rates rather than higher ordinary income rates of IRAs,” he added.
“While you will need to pay taxes on capital gains and dividends each year, using index funds with low turnover should keep these taxes to a minimum,” he said.
