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President Biden is pushing the idea of applying the wash sale rule to digital assets as a part of the broader discussions over the debt ceiling. This policy would increase the tax burden on digital asset transactions by roughly $17 billion, according to the Joint Committee on Taxation (JCT). Additionally, this expansion of the wash sale rule would be putting the cart before the horse because Congress has yet to develop a concrete framework for determining whether digital assets are commodities or securities.

Wash Sale Rule Explained

Under current Internal Revenue Service (IRS) rules, a wash sale occurs when an investor sells “stock or securities” at a loss, and either 30 days before or after the sale, purchases a “substantially identical” stock or security. The IRS prohibits any deduction of losses when a transaction like this occurs. 

President Biden’s Fiscal Year 2024 budget proposal includes application of the wash sale rule to digital assets. This was added in hopes of raising approximately $24 billion in revenue. However, JCT estimates it will raise about $17 billion over a decade.

Democrat Plan to Tax Digital Assets Grossly Expands IRS Power  

Although no formal bill text has been released, the model for any future language will likely be derived from what Democrats already attempted to enact in 2021. Then-chairman Richard Neal (D-Mass.) of the House Committee on Ways and Means released text for the tax portion of the budget reconciliation bill, which included a section that restricted crypto investors from being able to deduct losses on certain transactions.

The draft language amended the tax code to specify that foreign currencies, commodities, and digital assets qualify under the IRS’s rules for wash sales. The language would have applied to investors who directly purchase digital assets and derivatives contracts containing underlying digital assets (e.g., options and futures contracts). While the current wash sale rules apply to options with underlying stock or securities, they do not currently apply to losses from “trades of commodity futures contracts.” Applying the wash sale rules to futures contracts with underlying digital assets would be a gross expansion of the IRS’s power. Eliminating the tax deduction option for losses on wash sales of futures contracts would be an increase of the tax burden on individuals transacting digital assets.  

Moreover, Congress and federal regulators have so far failed to develop a concrete framework for determining whether digital assets are commodities or securities. At the very least, a framework for differentiating digital commodities vs. securities must be adopted first. The easiest route may be to separate the Howey test from “categorizing” digital assets. 

Additionally, without guidance from the IRS, applying wash sale rules to digital assets would create confusion among investors about what constitutes a “substantially identical” purchase of a digital asset. Uncertainty could compel investors to slow trading or stop altogether to avoid any potential punishment from the IRS—creating a chilling effect on transactions within the digital asset industry.

Democrats are on the warpath when it comes to raising revenue. This is made clear by their eagerness to reel in revenue by applying wash sale rules to every type of investment or tool to hedge against risk.

Instead of crying foul on this “tax loophole,” lawmakers should reject this proposal to send more taxpayer dollars to Washington.