Crypto Winter and Tax

Considerations for the current crypto winter and implications of the future of tax.

First coined in 2018 after Bitcoin’s value dropped by 80% within 12 months, the crypto winter is a period of time in which the price of crypto assets remains low. While this ‘winter’ has been likened to the potential start of an ‘ice age’ - implying its permanence - others have more optimism, suggesting that it will merely cleanse the space of “fundamentally worthless projects” and return to its glory days of highly valued crypto with only credible and well-founded projects remaining. Additionally, unlike the first crypto winter, there is no sense of impending doom for the state of crypto this time around. Rather, there is optimism for what is to come as to date there are more corporations and financial institutions adopting and experimenting with crypto, and more regulation being introduced by the US government. The combination of acceptance by major corporations and attempts to regulate indicates that crypto is here to stay, and here to grow.

Corporations and Governments

With consideration of the volatility in crypto, there are a number of potential outcomes for the approach towards the treatment of tax in our near future. While crypto was gaining in both popularity and value over the years, governments and businesses internationally and locally were becoming more and more accepting of it – from acknowledging its value, to banks adopting their own coins, to creating the ability to pay certain taxes using specific cryptocurrency. However, in seeing the rapid decline of its value in such a short period of time might make these governments and businesses rethink their approaches to its use. 

We might see US state governments slowing their adoption to pay taxes using crypto. We might see reluctance for businesses to also accept crypto payments. Governments who were on the fence before the crypto winter about legalizing crypto are sure to either remain on that fence or quickly choose the side away from accepting it. So far, only two US states (Colorado and Utah) have decided to press on with planning and implementing their programs to allow tax payments in certain crypto, with all other states holding fire on their plans and being encouraged to rethink any crypto tax payment programs. OR, perhaps once the slow-moving nature that is government finally makes a decision about how they want to respond to this crypto winter, said winter will have blown over and the state of crypto will be entirely different.

Tax-Loss Harvesting

Aside from the speculation of what we might expect in the tax space in the future for crypto, let’s consider the current practices amidst this crypto winter. The current trend in today’s state of crypto is to apply tax-loss harvesting practices. In essence, tax-loss harvesting is typically applied to an investor’s portfolio to minimize short-term capital gains tax by selling when the asset is at a loss and then buying a similar asset back to maintain the balance of the portfolio. It has been suggested for owners of crypto to apply the same principles to their wallets, as a means to offset the short-term capital gains tax, as they are sure to hit a loss during this crypto winter.

A key difference between a typical investor’s portfolio and a crypto owner’s wallet, however, is the application of the wash-sale rule. In this rule, the investor must wait thirty days before being allowed to buy back the same/similar stocks and securities. As there has been no published crypto guidance by the IRS since 2019 and no current requirement to apply the wash-sale rule in their selling/purchasing of crypto, it is up to the personal judgment of the user to decide how long they can wait before buying back their asset. Legislators are actively working to close this planning tool so users of the strategy should keep up with legislation.

It is important to also note that some risks in tax-loss harvesting of crypto includes potential transaction fees incurred through the selling/buying of the crypto, and the deferment of capital gains to the future. It is important to acknowledge that in buying back the crypto asset, your cost basis will be lower, at the fair market value of your previous sell. This means that future capital gains tax could be higher should you sell in the future when the asset is at a high value.