Proposed infrastructure bill would subject cryptocurrencies to wash sale and constructive sale rules

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In a report outlining its proposals to raise revenue to finance infrastructure spending, the House Ways and Means Committee proposed explicitly subjecting cryptocurrency to the “wash sale” and “constructive sale” rules of the Internal Revenue Code.

A wash sale occurs when an individual sells a stock or a security at a loss, but within 30 days before or after this sale, the individual buys a "substantially identical" stock or security or acquires a contract or option to do so. Section 1091 of the Code prevents the individual from immediately using such a loss by effectively ignoring the sale transaction and adding the amount of loss to the cost of the replacement stock or security; in effect, the loss is deferred until the replacement stock or security is itself sold.

Section 1091 currently applies only to stocks or securities, and therefore the wash sale rule does not currently apply to cryptocurrency since the IRS treats cryptocurrency as property and not a stock or a security. The Committee’s proposal would add to the list of items subject to the wash rule “[a]ny digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology as specified by the” Treasury Department, which is intended to encompass cryptocurrency and other digital assets. If the Committee’s proposal is enacted, cryptocurrency transactions occurring after December 31, 2021 would then be subject to the wash sale rule.

A constructive sale occurs when a taxpayer takes an offsetting position with respect to property that the taxpayer owns (a “long” position) that effectively results in the long position being sold for economic purposes. Examples of this include making short sales against similar or identical positions (so-called short sales against the box) and entering into futures or forward contracts that call for the delivery of an already-held asset. These transactions can allow taxpayers to delay the realization of gains on sales of long positions, thereby avoiding higher tax rates on short-term capital gains.

Section 1259 of the Code, with certain exceptions, treats such constructive sales as triggering the gain on the long position for tax purposes. Section 1259 currently applies only to “appreciated financial positions,” which includes only shares of stock, debt instruments, or partnership interests.

The Committee’s proposal would add “digital assets” to the list of items subject to the constructive sale rules, and which are defined using the same “digital representation” language as noted above. If the Committee’s proposal is enacted, then constructive sales of cryptocurrency occurring after enactment would be subject to Section 1259.