Tax Rules and Digital Assets: What’s Changing

Since the launch of Bitcoin spot exchange-traded funds (ETFs) early in 2024, the traditional financial world has increasingly accepted digital assets as a new asset class. This has led to more conversation about modernizing the tax code in various ways with respect to this new type of asset. Among the topics frequently discussed is whether digital assets should be made subject to the wash sale and constructive sale rules.

Wash Sale Rules

The wash sale rules of Internal Revenue Code (IRC) Section 1091 disallow capital losses when the same or substantially identical property, or contracts to acquire such, is acquired within the 61-day window beginning 30 days before and ending 30 days after the date of sale. The provision was implemented to prevent abusive tax loss harvesting using sales that lack economic substance. Because Sec. 1091 specifically refers to “stock or securities,” it does not appear that the wash sale rules apply to many digital assets.

One exception, as the U.S. Department of the Treasury’s (Treasury) new digital asset broker regulations from July 2024 make clear, is digital assets that are tokenized securities. Such tokenized assets are subject to the wash sale rules provided that they represent a tokenized version of a stock or other security that would itself be subject to wash sale treatment.

In July 2023, the Senate Finance Committee published an open letter to the digital asset community seeking input on various tax reform proposals, among them the idea of expanding the wash sale rules to include digital assets. The response from tax professionals and policy experts was broadly in favor of expanding wash sale treatment. The vast majority of digital assets are held for investment, and experts see little if any reason why they should be specially exempted from the same rules that apply to most other types of investments. Tim Savage, partner-tax of Weaver’s Blockchain and Digital Assets practice, expressed a similar view in his own response to the Senate Finance Committee.

Constructive Sale Rules

The constructive sale regime of IRC Section 1259 requires recognition of gain when a taxpayer “constructively sells” an appreciated investment by selling that same asset short or entering into certain types of contracts to deliver said asset (futures, forwards, etc.). Section 1259, like Section 1091, specifies certain types of assets — namely stock, debt instruments and partnership interests. As such, the rule does not currently apply to most digital assets.

The idea of expanding the constructive sale rules to include digital assets also appeared as one of the topics in the Senate Finance Committee’s 2023 open letter, and it received a similar response to the proposal on wash sales. Seeing little reason to specifically exempt digital asset investments from the rules that generally apply to other investments, most experts were in favor of extending the constructive sale rules.

Wash Sale and Constructive Sale Rules and Tokenized Securities

With regard to tokenized securities, the Treasury’s broker regulations did not specifically address the application of constructive sales as it did with wash sales. However, given that the constructive sale provisions use the same “substantially identical property” standard as the wash sale provisions, it is clear that constructive sales should also apply to tokenized securities that represent assets that would normally be subject to the constructive sale rules.

What’s Next for Digital Assets?

There have been various proposals to extend the wash sale rules to digital assets in recent years. The idea was included in the Biden administration’s list of revenue proposals for both 2023 and 2024, and it is also in the Lummis-Gillibrand Responsible Financial Innovation Act proposed by Senators Cynthia Lummis (Republican-Wyoming) and Kirsten Gillibrand (Democrat-New York) in July 2023. Given the consideration from the Senate Finance Committee, the relatively broad, nonpartisan consensus in favor and a new administration that seems more favorable to providing regulatory clarity for this industry, it is likely that the wash sale and constructive sale rules will be expanded to include digital assets in the near future.

Digital assets continue to evolve at a remarkable rate, and the tax rules are catching up with them. It’s critical to understand the tax rules on digital assets to evaluate and prepare for potential changes. Our professionals can help simplify the complexities. Contact us today.

Authored by David Hensley 

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