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How Crypto Investors Use ‘Wash Trading’

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To say the crypto market took a hit in 2022 would be the biggest understatement of the year. Unfortunately for crypto investors, this has resulted in huge losses and battered confidence in the space.

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However, there is a strategy that some people use at the end of the year to compensate for some of these losses: washing trade.

The Internal Revenue Service’s wash sale rule prohibits investors from claiming losses on securities sold at a loss and redeemed within 30 days, preventing taxpayers from using “artificial” losses to offset their gains and reduce their taxes on capital gains.

Although there is a chance that the wash sale rule will apply to the crypto industry in the future, as of now, that is not the case – and Harvesting losses through this tactic is possible for investors.

Crypto is not considered equity

Indeed, the IRS says that for federal tax purposes, virtual currency is treated as property.

“General tax principles applicable to real estate transactions apply to transactions using virtual currency,” according to the IRS. As such, crypto is not subject to equity rules.

“Until regulation catches up, wash sale rules do not currently apply to crypto,” said Nick Reilly, expert community member at social crypto platform and market Earnity. . “Therefore, due to the recent bear market we have experienced in the space, many investors have the opportunity to take positions where they may have losses and use them to offset current and future capital gains. “

Reilly explained the steps: First, sell the positions in which you have a loss, which “realizes” the loss for tax purposes.

“You can do whatever you want with the product, like buying back the same token or investing in something different,” he said. “Document the transaction accurately, so you know when you originally bought the token and when you ultimately sold it. Then report the losses – and potential gains – using tax form 8949. Note: this step can be performed using crypto-tax software.

To put it into context, as of December 19, the global crypto market cap stood at $807.81 billion – a far cry from the $3 trillion it hit in November 2021, according to data from CoinMarketCap. . Bitcoin – the largest crypto by market capitalization – was hovering around $17,700 on December 19, down a sharp 74.3% from its November 2021 all-time high of $68,790.

The shadow sell strategy is a unique trait in crypto markets and presents a silver lining during tough markets, said Jackson Wood, portfolio manager at Freedom Day Solutions and a community expert at Earnity.

“Losses made in crypto can also be used to offset gains in other asset classes like real estate, stock investing, etc.,” Wood said. “Sophisticated investors need to understand this unique opportunity. When used appropriately, [it] can be a beneficial tactic in portfolio and asset management.

Regulation desired by some

While this is indeed a silver lining for investors, some experts believe it reflects the lack of clarity in the regularity of space – something many are asking to avoid future meltdowns.

“Unfortunately, many crypto-related parties are using wash trade as a popular way to reap their tax losses. Until the law changes, there is no reason to comment on this form of tax-loss harvesting,” said Bob Ras, co-founder of Sologenic. “Having said that, if there was more regulatory clarity, then maybe wash trading would become more compliant with the rules for equities. But until then, unfortunately, it looks like it’s legal for people to do it. The sooner the Wild West days of crypto end, the sooner the industry will mature and grow.

Additionally, wash trading applies to NFTs, said Ganesh Swami, co-founder and CEO of covalentadding that “it’s not a big aspect of our industry.”

“But if we had clearer regulations for the industry and better data coverage, then washing trade would not be a problem,” Swami said. “At the end of the day, it’s legal, so what would you expect? Traffic [traditional finance] stock traders would do the same if it weren’t so easy to get discovered. So, of course, it will happen in crypto – it’s the law, it’s easy to cover our tracks, and tax software makes wash trading super efficient because it’s very precise.

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This article originally appeared on How Crypto Investors Use ‘Wash Trading’

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