Spot bitcoin ETFs are barely a week old, but tax attorneys and accountants are already warning investors who actively trade the funds the same way they do cryptocurrency itself that they may miss out on a tax saving strategy. Right now, investors who regularly trade cryptocurrency can take advantage of a quirk in the tax code : They can sell losing positions in bitcoin and ether, harvest this realized loss to offset taxable capital gains elsewhere in their portfolio, and then immediately buy back the crypto position on the cheap to benefit from its recovery. Investors in stocks, bonds, mutual funds and exchange traded funds can also take advantage of their losses and use them to counter capital gains – a move that’s known as tax-loss harvesting. But there’s a catch with conventional assets: the wash sale rule . That means if investors sell an asset at a loss and buy a substantially identical security within 30 days before or after the sale transaction, the Internal Revenue Service won’t allow them to claim the loss on their return that tax year. Now, tax professionals are flagging a potential wrinkle that may arise: Even though bitcoin itself isn’t subject to the wash sale rule, a spot bitcoin ETF very well may be. “Sophisticated investors won’t have a problem with this,” said Stephen Turanchik, a tax attorney at Paul Hastings and a member of the Digital Assets Tax Task Force with the American Institute of CPAs. “The ones who get caught up are the ones who are sloppy.” Property versus security Under federal tax law, the IRS deems cryptocurrency to be property . “Under current law, the wash sale rule applies to stocks and securities, that is how the law is written,” said Andrew Gordon, CPA and attorney at Gordon Law Group. “Interpreting the law, most people don’t think crypto falls under the wash sale rule because it is neither a stock nor a security – it’s a digital asset and a separate type of property,” he said. In reality, however, crypto investors are pretty active traders. “I get that it’s ‘property’ per the IRS, but let’s get real: People trade it like a stock,” said Dan Herron, certified financial planner and CPA at Elemental Wealth Advisors in San Luis Obispo, California. “I can see people trading in and out of that ETF.” Until the IRS issues guidance on how the wash sale rule may apply to spot bitcoin ETFs, tax attorneys are advising over investors in these funds to consider adjusting their strategy. Managing limitations At its core, that means investors should avoid swapping in and out of the same spot bitcoin ETF within the 61-day limit if they had sold the position. “If you were concerned that the wash sale rule applied, you would presumably not go in and out of the same [exchange traded product], and you would find another vehicle that is sponsored by a different sponsor or has a different fee structure,” said Richard LaFalce, partner at Morgan Lewis. Investors who wanted to dump a losing position in a spot bitcoin ETF may also want to snap up a fund with a different crypto-related strategy altogether: perhaps an offering that invests in crypto-linked stocks , for instance. This also raises the question of whether dumping one spot bitcoin ETF for another would be deemed substantially identical. “If the underlying assets are exactly the same, then you have a wash sale problem,” said Turanchik, noting that these funds are “brand spanking new.” “Whether the ETF is considered substantially similar is going to be on a case-by-case basis,” he said. Finally, even if the IRS disallows a write-off of a loss due to a wash sale, the amount of the disallowed loss is added to the cost basis of the replacement asset you bought. In turn, this higher cost basis means you might owe less in taxes on the gain when you finally sell the new holding. “You may not be allowed the loss on the current trade, but it gets added as basis to your new security that you acquire,” Turanchik said.
Investors may miss out on this key tax loophole if they actively trade a spot bitcoin ETF
