FACT CHECK: Biden's closing of the crypto wash trading loophole that was ALREADY closed for stocks back in 2008 can actually reduce taxes in many instances

Biden's new crypto tax law closes the loophole for crypto that was already closed for stocks back in 2008 in Section 1091 of the tax code.

So the rule isn't necessarily bad and can actually reduce taxes in common situations.

What is the Wash Sale Rule

Let's look at what the wash trading rule actually does: https://www.investopedia.com/terms/w/washsale.asp

If you make a substantially similar trade 30 days before or after a sale, the second sale counts as a continuation of the first sale for tax purposes. A "similar" trade has to be extremely similar. For example, VTI and SPY trade 99.9% in sync, but they are not considered similar for purposes of the wash sale rule because one is total market while the other is large cap S&P 500.

Institutions were taking advantage of this loophole (known as a bed-and-breakfast trade) to manipulate and reduce their taxes. For example, if they had profits of $10M, they could reduce their federal taxes by $3M by selling another trade at a loss, and then immediately rebuying that trade back within 30 days. Even I was aware of the trick and was using it back then.

Some people are complaining that this prevents them from qualifying for up to $3k in tax deductions per year. You'll still get those tax deductions from the losses, but you'll have to wait until the next time you sell outside of a wash sale. Also, you can buy a similar-performing but not legally "similar" asset (e.g. VTI vs SPY, Tesla common shares vs Tesla preferred shares).

How this rule could actually lower taxes

From this article:

The holding period of the wash sale securities is added to the holding period of the repurchased securities, which increases an investor’s odds of qualifying for the 15% favorable tax rate on long-term capital gains.

Long-term income tax is taxed at 0%, 15%, or 20% depending on your tax bracket, which is significantly lower than short-term tax rates.

Here's an example:

Let's say you're in the $80k tax bracket filing single, which puts you at the 12% federal income tax rate, but also at the 0% long-term capital gains tax rate.

If you make a crypto trade holding it for 11 months, and then rebuy it within the 30 days holding for another 2 months while making a profit of $20K, that trade is subject to wash trading rules. Instead of paying $2.4k in taxes for that trade, you now pay $0 in taxes, all thanks to wash trading rules.

That's a 100% reduction in taxes in this situation.

So the rule isn't necessarily bad.

Edit

Another thing I forgot to mention is that without wash sales, casual investors who don't pay attention to tax loss harvesting can really screw themselves over.

That's because tax loss harvesting is limited to $3K per year.

Here's another common example of the wash trading rule reducing taxes

Let's say in 2022 you had a loss of $100K in ETH, supposedly reducing your taxes by $30K. And then 2023 was a stellar year, so you gained $100K in another ETH trade in a wash trade.

• With the wash trading rule, the loss and profit cancel out, and your taxes are zero.
• Without the wash trading rule, your taxes across those 2 trades would be $27K.

You can only reduce taxes by $3K per year, so it would take 10 years to cancel those losses, which you're probably not going to get to do since you're likely going to have losses again within those 10 years.

Thus the wash trading rule also helps a lot in this situation.