MicroStrategy’s Bitcoin Wash Trade is Still Legal… For Now

But watch out for that economic substance doctrine, it’s a doozy

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The waning days of 2022 may be US crypto traders’ last chance to take advantage of a tax loophole that doesn’t exist in traditional finance: wash trading.

At least if certain politicians have their way. 

In a Wednesday SEC filing, MicroStrategy said it had sold 704 bitcoins, before repurchasing 810 bitcoins two days later — for effectively the same price. A parallel trade of regulated securities would be an illegal wash trade: selling and repurchasing the same shares within a defined period in an attempt to realize a loss and pocket a tax benefit. 

“Currently, the wash sale trading rule does not apply to crypto assets, and it is simply smart financial planning to do tax loss harvesting,” Kell Canty, CEO of Ledgible said. “This is exactly what Microstrategy has done here.”

When used to its full potential, tax loss harvesting gives traders the opportunity to offset ordinary income in a given year or in the future, according to Andrew Perlin, an accountant with TokenTax.

“If your capital losses for the year exceed your capital gains, you can use up to $3,000 of losses per year ($1,500 if you are married and filing separately) to offset regular income after reducing investment gain,” Perlin said in a recent blog post.

Offsetting capital gains with tax loss harvesting

Tax loss harvesting postpones tax obligations — it does not cancel those obligations. The idea for traders is that through tax-loss harvesting, investors can put more money into growing their portfolios, Perlin said. And realizing losses, in part, may reduce tax owed on capital gains. 

“This is how the logic works: By the time you pay the taxes you postponed through tax-loss harvesting, your portfolio would theoretically have generated significantly more than the tax amount you owe,” Perlin said. “In this scenario, you would end up with a higher dollar amount in the long run.”

As long as bitcoin and other cryptocurrencies continue to not be classified as securities, MicroStrategy’s move is technically legal, according to Arthur Teller, TokenTax’s chief operating officer. 

The Biden administration attempted to put an end to wash trading in crypto through an amendment to the Build Back Better Act, but the effort did not pass. The amendment would have made wash trading currencies, commodities and digital assets illegal, per the draft’s text

Even with a legal bitcoin wash trade, there is one concern taxpayers looking to pocket a loss benefit should keep an eye out for, Teller said: the economic substance doctrine. 

“If a transaction does not appear to have a legitimate business purpose or lacks economic substance, then the tax benefits associated with that transaction are disallowed,” he said. “Put another way, even though the wash sale rules don’t apply to crypto, these types of transactions may still result in disallowed losses.” 

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