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Does the Wash Sale Rule Apply to Crypto? (2023 IRS Rules)

At time of writing, there is no crypto wash sale rule in effect for US taxpayers, and crypto wash sales are technically legal. However, this is expected to change as legislation has already been proposed.

Wash Trading: What It Is and How It Works, With Examples

James Chen, CMT is an expert trader, investment adviser, and global market strategist.

​Somer G. Anderson is CPA, doctor of accounting, and an accounting and finance professor who has been working in the accounting and finance industries for more than 20 years. Her expertise covers a wide range of accounting, corporate finance, taxes, lending, and personal finance areas.

What Is Wash Trading?

Wash trading is a process whereby a trader buys and sells a security for the express purpose of feeding misleading information to the market. In some situations, wash trades are executed by a trader and a broker who are colluding with each other, and other times wash trades are executed by investors acting as both the buyer and the seller of the security.

Wash trading misleads investors into believing that trading volumes for a security are higher than they actually are, potentially increasing legitimate trading activity on the security in the process. Wash trading is illegal under U.S. law, and the Internal Revenue Service (IRS) bars taxpayers from deducting losses that result from wash trades from their taxable income.

Key Takeaways

  • Wash trading is an illegal type of trading in which a broker and trader collude to make profits by feeding misleading information to the market.
  • High-frequency trading firms and cryptocurrency exchanges may use wash trading to manipulate prices.
  • The IRS bars taxpayers from deducting losses that result from wash trades from their taxable income.

Understanding Wash Trading

Wash trading was first barred by the federal government after passage of the Commodity Exchange Act in 1936, a law that amended the Grain Futures Act and also required all commodity trading to occur on regulated exchanges. Prior to its proscription in the 1930s, wash trading was a popular way for stock manipulators to falsely signal interest in a stock in an attempt to pump up the value, so that these manipulators could make money shorting the stock.

Commodity Futures Trade Commission (CFTC) regulations also prohibit brokers from profiting from wash trades, even if they claim they weren’t aware of the trader’s intentions. Brokers therefore must perform due diligence on their customers to make sure that they are buying shares in a company for the purpose of common beneficial ownership.

The IRS also has strict regulations against wash trading and requires that taxpayers refrain from deducting losses that result from wash sales. The IRS defines a wash sale as one that occurs within 30 days of the buying of the security and results in a loss.

Wash Trading and High-Frequency Trading

Wash trading returned to the headlines in 2013, right as the phenomenon of high-frequency trading was becoming widespread. High-frequency trading is the practice of using super fast computers and high-speed internet connections to perform upwards of tens of thousands of trades per second.

Starting in 2012, then-Commissioner of the Commodity Futures Trading Commission Bart Chilton announced his intention to investigate the high-frequency trading industry for violations of wash trading laws, given how easy it would be for firms with this technology to enact wash trading under the radar.

In 2014, the Securities and Exchange Commission (SEC) charged Wedbush Securities for failing “to maintain direct and exclusive control over settings in trading platforms used by its customers,” a failure that enabled some of its high-frequency traders to engage in wash trades and other prohibited and manipulative behavior.

Wash Trading and Cryptocurrencies

In recent years, wash trading has infiltrated the cryptocurrency space as well. The desire to give the impression of popularity and high trading volumes is clear: there are thousands of cryptocurrency tokens available throughout the world, and most have a difficult time distinguishing themselves. But even the most popular cryptocurrencies, including Bitcoin, experience wash trading.

A 2022 study of 157 cryptocurrency exchanges by Forbes found that over half of all reported Bitcoin trading volume is either fake or non-economic wash trading. Cryptocurrencies are particularly vulnerable to pump-and-dump schemes, in which a combination of inflated trading volumes and strong publicity or recommendations from insiders artificially boosts a token’s value, allowing certain holders to sell at a massive profit while interest is high.

There are multiple potential reasons for the prevalence of wash trading in the crypto space. Even major digital currencies like Bitcoin often lack universally accepted methods of calculating daily trading volume. This leads to cryptocurrency firms producing oftentimes wildly divergent figures for historical trading volumes. Cryptocurrency exchanges themselves often lack legitimacy, and there have been many high-profile public collapses of token exchanges in recent years. Extreme volatility in the cryptocurrency space may incentivize rapid buys and sells. Finally, crypto’s murky status with U.S. and other government regulators creates a further opportunity for misleading trade activity.

Examples of Wash Trading

Wash trades are essentially trades that cancel each other out and have no commercial value, as such. But they are used in a variety of trading situations.

For example, wash trades were used in the LIBOR scandal to pay off brokers who manipulated the LIBOR submission panels for the Japanese yen. According to charges filed by the U.K. financial authorities, UBS traders conducted nine wash trades with a brokerage firm to generate 170,000 pounds in fees as a reward to the firm for its role in manipulating LIBOR rates.

Wash trades can also be used to generate fake volumes for a stock and pump up its price. Suppose a trader XYZ and brokerage firm collude to buy and sell stock ABC rapidly. Noticing activity on the stock, other traders may put money into ABC to profit from its price movements. XYZ then shorts the stock, thereby profiting from its downward price movement.

What Is Wash Trading?

Wash trading refers to an illegal activity in which a single trader buys and sells the same security in order to generate misleading market information. Wash trading is often performed to artificially inflate the trading volume of a security.

What Is an Example of Wash Trading?

The IRS defines a wash sale as one that happens within 30 days of the purchase of the same security and generates a loss.

Why Would Someone Do Wash Trading?

In some cases, wash trading bolsters the trading volume of a security, potentially inspiring more legitimate trade activity. Wash trading can also be used to help artificially boost the price of the security as part of a pump-and-dump scheme.

The Bottom Line

Wash trading is an illegal activity in which a trader buys and sells the same security, either within a short period of time or on separate exchanges, in order to inflate the trading volume or the price of that security. Wash trading can occur across a variety of industries and assets, but it has recently become a major consideration for the cryptocurrency and high-frequency trading spaces.

Does the Wash Sale Rule Apply to Crypto? (2023 IRS Rules)

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  • The wash sale rule prohibits sales of securities at a loss and reacquiring them within 30 days in order to prevent taxpayers from making “artificial” losses to lower tax liability.
  • There is no crypto wash sale rule in effect for US taxpayers, and crypto wash sales are technically legal. However, legislators are working to close this loophole, and we recommend avoiding crypto wash sales.

What is the crypto wash sale rule?

A wash sale occurs when a holder sells crypto or security for a loss and quickly rebuys the same or similar crypto or security to receive tax benefits. If US crypto users buy back their crypto assets immediately after a sale, this is a crypto wash sale.

The easiest way to avoid the wash sale rule is to wait 30 days after selling an asset and then before buying it back. At the time of writing, the wash sale rule does not technically apply to crypto assets. However, there is proposed legislation aimed at banning crypto wash sales.

As of 2023, the crypto wash sale rule remains a gray area. Because of this, it is safer to avoid crypto wash sales. In accordance with 26 U.S. Code § 1091, loss from wash sales of stock or securities, securities (e.g., investments such as stocks and bonds) are subject to the wash sale rule.

This means that if an investment you hold has lost value, you cannot sell it to claim losses and buy it back within 30 days. This rule prevents taxpayers from using “artificial” losses to offset their gains and lower their capital gains tax liability.

How does the crypto wash sale rule work?

The wash sale rules for crypto are easily explained. The main idea of the wash sale rule is that the use of capital losses for tax purposes if an investor buys back a substantially identical security or crypto asset within 30 days of selling it is not allowed.

Here’s a crypto wash sale rule example:

  • On December 30, Aaron has $15,000 of gains and $5,000 of losses, for an overall gain of $10,000. He is also holding 20 BNB that has a cost basis of $10,000 but a current fair market value of $4,000.
  • Aaron sells 20 BNB for $4,000, realizing a capital loss of $6,000.
  • Within 30 days before or after the sale, Aaron could buy the same or a substantially identical security. So on January 5, Aaron he decides to buy 20 BNB for $4,200.
  • On his taxes, Aaron reports the $6,000 loss on 20 BNB and uses it to offset capital gains, lowering his overall gains from $10,000 to $4,000, which is correct since the wash-sale rule applies. His loss is disallowed for tax purposes.
  • The cost basis of the Aarons new security is adjusted to reflect the disallowed loss.
  • If Aaron decides later to sell the new security for a gain, the adjusted cost basis is used to calculate the taxable gain.

How to save taxes with the crypto wash sale rule

The IRS wash sale rule does not currently apply to cryptocurrency because it considers virtual currencies to be property rather than securities. This effectively means there is no crypto wash sale rule at time of writing.

This means that technically crypto wash sales are allowed. However, lawmakers and regulators have suggested that this could soon change.

In September of 2021, a House Ways and Means Committee proposal included language applying wash sale rules to digital assets, i.e. creating a crypto wash sale rule. Although the Build Back Better bill stalled in Congress, these developments underlined the government’s interest in the matter.

Biden conceded in 2021 that the Build Back Better Act would not be passed by the end of the year, but he remained steadfast in his intent to pass it as soon as possible. In March of 2022, President Biden signed the bill into effect, calling for federal agencies to pay closer attention to crypto wash sales.

This series of events demonstrates that federal agencies are acting quickly to change the legislation surrounding wash sales of crypto. Our expert advice? Use your best judgment with regard to the ever-evolving field of cryptocurrency, especially with a pending crypto wash sale rule in legislation. When in doubt, play it safe.

From forms to filing, TokenTax covers all your crypto tax needs.

How does the wash sale rule impact my tax bill?

The aim of a crypto wash sale is to minimize tax liability by reducing capital gains. Through a crypto wash sale, you could pay less in taxes.

As noted, however, this loophole could be closed, so we strongly recommend avoiding wash sales.

Safer ways to harvest crypto losses

There are safer strategies that are effective in accomplishing this same goal:

  1. If you rebuy a crypto asset after the 30 day period passes, your actions no longer classify as wash sale trading and will avoid any future crypto wash sale rule, presuming the rule is the same as that which currently exists for securities.
  2. You may trade the depreciated asset for a coin with which its price is closely correlated. You would then hold that correlated coin for more than 30 days and then repurchase the original asset.

Safer tax loss harvesting example

Because Uniswap is an Ethereum-based DeFi exchange and the DeFi Pulse Index coin is pegged to 10 of the top-performing Ethereum DeFi coins, $UNI and $DPI are closely correlated; over the past year their correlation has been 89%.

Rather than completing a wash sale, if you wanted to tax loss harvest with your UNI, you could sell it at a loss, purchase the same amount of DPI, and hold the DPI until the wash sale period passes, at which point you could repurchase UNI.

For more information on safe crypto tax loss harvesting, visit our helpful post on how to report crypto losses on your taxes.

How TokenTax can help

With specific attention to the tax regulations, or crypto wash sale rule questions in your country, TokenTax crypto tax software calculates capital gains totals using various crypto accounting methods, including FIFO, LIFO, HIFO, the average cost method, and our proprietary Minimization.

With Minimization, we’ve built upon the HIFO accounting method with a proprietary approach that automatically makes adjustments based on an individual’s tax rate to minimize crypto taxes as much as possible.

Schedule a FREE crypto tax consultation

Wash sale rule crypto FAQs

Here are answers to some frequently asked questions about the crypto wash sale rule.

Is the wash sale rule 30 days for crypto?

The wash sale rule states that your capital loss cannot be claimed on securities if you bought the same asset within 30 days of a sale. Therefore, it’s reasonable to assume that the wash sale rule does not apply to cryptocurrency based on current IRS guidance.

Does the wash sale rule carry over into the next year?

Yes. If you sell the asset and reacquire it within 30 days, this is considered a crypto wash sale, whether or not the sale carries over into the next calendar year. So, if you sell on December 15 and purchase back on January 1, this is considered a wash sale.

Can you still do wash sales with crypto?

Technically, yes, there is no crypto wash sale rule at present. However, the Biden administration has begun to investigate crypto cases more closely, and it is likely that the loophole that currently allows crypto wash sales will soon be closed, making crypto wash sales illegal.

How can I tell which one of my assets is currently trading at a loss?

The only way you can see your overall portfolio performance is by tracking all of your crypto profits and losses. You can easily do this with our software at TokenTax, and if you’d like support, our team of experts is available to help.

Will the wash sale rule for crypto change in the future?

Given recent rulings on crypto cases and the Build Back Better Act (signed into effect in March of 2022), it is reasonable to expect that crypto wash sales will soon be declared illegal.

Can you sell crypto for a loss and buy back?

Yes, you can sell crypto for a loss and buy back any time. The wash sale rule applies when traders do this rapidly in order to secure losses for tax purposes. The safest way to do this for tax purposes is to wait 30 days from the time of sale and then purchase back.

How do I bypass the wash sale rule?

The simplest way to bypass the wash sale rule is to wait 30 days after selling an asset and then before buying back. The IRS wash sale rule declares that if a trader sells a security at a loss and then repurchases within 30 days, the initial loss cannot be claimed for tax purposes.

Is wash sale loss disallowed for crypto?

At time of writing, there is no crypto wash sale rule in effect for US taxpayers, and crypto wash sales are technically legal. However, this is expected to change as legislation has already been proposed.

To stay up to date on the latest, follow TokenTax on Twitter @tokentax.

Related Content

Tynisa (Ty) Gaines, EA has more than 20 years of experience as a tax professional. Ty has published numerous tax articles, two tax e-books, and an academic publication on cryptocurrency for the National Income Tax Workbook.

Arthur came to TokenTax after 12 years at KPMG. A specialist in partnership taxation and enterprise tax software, he is a licensed CPA in both California and Illinois and a member of the AICPA.

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