What happened
Many cryptocurrencies -- Chainlink (LINK 1.40%), Algorand (ALGO -4.99%), and Ripple's (XRP 0.50%) XRP token among them -- suffered significant losses on Monday on the heels of new tax rules proposed by Democrats in the U.S. House of Representatives. Those tokens were down roughly 5.7%, 3.3%, and 4.1%, respectively, as of 4:30 p.m. EDT.
As part of the massive infrastructure bill working its way through Washington, House Democrats have put forward a series of potential tax code changes that include raising the top capital gains rate from 20% to 25% and altering classifications that allow crypto traders to take advantage of wash-sale tax law loopholes. The proposed changes would likely result in higher tax liabilities for short-term, high-volume cryptocurrency traders.
Image source: Getty Images.
So what
If investors sell cryptocurrency or stock at a loss, they qualify for a capital gains tax deduction. Under the rules that apply to securities, investors have to wait at least 30 days before buying back the stock they previously sold at a loss. Otherwise, the earlier sale is classified as a "wash sale" and is not eligible for that tax deduction. However, the tax setup is a bit different when dealing with crypto.
Because cryptocurrencies are currently classified as property by the IRS rather than securities, they are not subject to the full wash-sale rules. That paves the way for more versatile short-term trading, as traders are able to sell tokens at a loss and then buy back into their positions in less than 30 days, but still take advantage of capital gains tax deductions.
Now what
While the proposed changes on cryptocurrency wash sales still have significant legislative hurdles to clear before they could go into effect, it's not unreasonable to think that such a regulatory shift will be instituted at some point. More robust regulation is a core risk factor for cryptocurrency investors.
The suggested wash-sale change would likely leave some crypto traders with higher tax bills, but the potential shift would have a relatively minor impact for many holders of Chainlink, Algorand, and XRP tokens. It's probably the potential for subsequent, more disruptive regulatory changes that investors should be more concerned about.
