New cryptocurrency tax law proposals by the House Ways and Means Committee
On September 13th, the House Ways and Means Democrats proposed legislative changes 1 that, if enacted, would impact the manner in which gain or loss is determined with respect to actual or certain deemed sales of cryptocurrencies. The legislation recently underwent the markup process and is now with the House Budget Committee. 2 The proposals generally extend the “wash sale rule” and the “constructive sale rule”, which ordinarily only apply to certain transactions involving stock and other securities, to also apply to “digital assets,” such as cryptocurrencies. These amendments may present challenges to cryptocurrency investors.
Amendments to Section 1091 Wash Sale Rule
As presently drafted, the so-called “Wash Sales rule”, section 1091 of the Internal Revenue Code, limits the ability of a taxpayer to utilize a loss recognized from the sale of a stock or security when substantially identical stock or securities were acquired or sold (or a contract relating to such acquisition was entered into) within 30 days before or after such date. This rule effectively prevents taxpayers from harvesting losses and then re-acquiring the same type of investment asset. The proposed legislation would expand the application of this provision to “digital assets,” such as cryptocurrencies, which historically have not been subject to the provision because the IRS has classified them as property rather than as securities. If enacted, these amendments would apply to sales occurring after December 31, 2021, and could reportedly raise up to $16 billion dollars over the next decade.
Changes to Section 1259 Constructive Sale Rule
Under existing law, the Tax Code provides that a sale is deemed to occur when a taxpayer undertakes certain transactions (e.g., entering into a hedge or a swap involving the same or identical appreciated stock, debt or partnership interests currently held by the taxpayer). The proposed legislation would expand this constructive sale rule to also apply to transactions involving specified digital assets, including cryptocurrency. Thus, for example, an investor that owns $100,000 of Bitcoin that was acquired at a cost basis of $60,000 would recognize $40,000 of gain, if the taxpayer enters into a short sale transaction involving Bitcoin.
Eversheds Sutherland Observation: The proposed legislation generally seeks to treat cryptocurrency like other types of financial assets and therefore subject sales of cryptocurrency to similar limitations regarding the harvesting of losses (in the case of wash sales) or gain recognition in the case of certain constructive sales transactions. In many instances, it would appear reasonable to treat cryptocurrency as functionally equivalent as other types of investible financial instruments. However, the rationale for parity seemingly fails when considering how these rules may apply to cryptocurrency functioning as a store of value (and not as an investment).
For instance, many cryptocurrencies are unable to be acquired or exchanged for fiat currency. Accordingly, certain gateway cryptocurrencies (Bitcoin or Ethereum) may be initially acquired using fiat currency and then exchanged in order to acquire other cryptocurrencies. Likewise, sales or dispositions of certain cryptocurrencies positions are regularly settled in Bitcoin or Ethereum and not fiat currency. To the extent that investment activity is undertaken in non-gateway cryptocurrencies, transactions into or out of such cryptocurrencies would necessitate transactions in gateway cryptocurrencies. Accordingly, the frequency of such transactions may regularly implicate the wash sales rule. However, the wash sale rule may chill enthusiasm for investment into cryptocurrencies.
The House is expected to vote on the proposal later this month.
1 See §§ 138151 and 138153 of Amendment in the Nature of a Substitute to the Committee Print Offered by Mr. Neal of Massachusetts (as reported by House Ways and Means Comm., September 12, 2021), https://waysandmeans.house.gov. See also Joint Committee on Taxation, Description of the Chairman’s Amendment in the Nature of a Substitute to the Committee Print Relating to Infrastructure Financing (Subtitle F), Green Energy (Subtitle G), The Social Safety Net (Subtitle H), and Prescription Drug Pricing (Subtitle J) (JCX-43-21), September 13, 2021, www.jct.gov.
2 See H.R.5376 – 117th Congress (2021-2022): To provide for reconciliation pursuant to title II of S. Con. Res. 14, H.R.5376, 117th Cong. (2021), https://www.congress.gov/bill/117th-congress/house-bill/5376/text. This markup of the legislation does not change the language proposed by the House Ways and Means Committee as it relates to these rules.