Regulating Crypto Markets through the Build Back Better Act: Crypto Investors’ Future Compliance with Wash Sale Rules

Gavin Martin 

Associate Editor

Loyola University of Chicago, JD 2023

The Build Back Better Act, which passed through the House of Representatives in November 2021, has been stalled in the Senate for several months. Senate Majority Leader Chuck Schumer has insisted that Democrats will work until the bill is passed. Within the Build Back Better Act, cryptocurrencies are shifted from being treated like property to being treated more like traditional securities, subjecting all digital currencies to wash rules under Section 1091. With cryptocurrencies collectively evaluated at upwards of $3 Trillion in 2021, crypto investors under the Build Back Better Act would be subject to the regulatory anti-abuse rules that currently apply to both stocks and bonds. This move by Democrats is for taxing purposes, but ultimately will call into question the IRS’ ability to regulate certain crypto transactions and asset disclosures. Additionally, questions have been raised as to the future regulation of cryptocurrencies and what that will mean for one of the most volatile trading markets.

Crypto investors’ future compliance with wash sale rules

The wash sale rule is an Internal Revenue Service (IRS) regulation that prevents a taxpayer from taking a tax deduction from a security that is sold in a wash sale. In short, a wash sale is when an investor sells or trades a stock or bond at a loss, and within 30 days before or after, buys another one that is substantially similar. Without a wash sale rule in place, investors could reduce their taxes through deductible losses.

In the status quo, cryptocurrencies are treated as property and not like securities. Currently, as cryptocurrencies are not treated like stocks or bonds, taxpayers can receive a substantial tax benefit by recognizing a loss on a sale from a cryptocurrency and then buying back the same coin or token. This regulatory enforcement through the Build Back Better Act is likely the byproduct of crypto volatility. For instance, suppose that Diana invests $3,000 in Ethereum at the beginning of the new year. The next April, Diana takes a loss and has $1,000 worth of Ethereum. Subsequently, Diana sells her $1,000 worth of Ethereum, and that same day buys $5,000 worth of Ethereum. The volatility of cryptocurrency means that within days or weeks, the subsequent investment of $5,000 could become $10,000. If Diana does in fact make this return on her subsequent investment in Ethereum, Diana still can benefit from the previous loss of capital gains in her investment portfolio. Again, this is because cryptocurrency is currently treated as a type of property. As a result of the proposed Build Back Better Act, Diana would be taxed at the more preferential long-term capital gains rate.

Overall, many believe that with the Build Back Better Act (in addition to other legislation), cryptocurrencies could become much less volatile in the future. With less volatility and more government oversight, it is likely that crypto assets will become commonplace in many portfolios.

Crypto, blockchain & compliance

With proposed measures to regulate crypto investors, questions have been raised regarding the ability to enforce compliance through Section 1091. This is due to the decentralized nature of cryptocurrency. Although there are crypto specific trading platforms that require taxpayers’ information, such as Binance, Coinbase, FTX Exchange, and Kraken—the initial popularity of crypto began (in part) due to its ability to be untraced and for the anonymity built into blockchain technology. Various websites and online marketplaces exist where it is easy to buy, sell, and trade cryptocurrencies that are untraceable. With this in mind, the ability to enforce these regulatory measures through disclosed transactions is in question.

Future crypto regulatory legislation

In addition to the Build Back Better Act, several bills have been introduced in the 116th and 117th Congress to regulate the trading and earnings from cryptocurrency. This included the Crypto-Currency Act of 2020 (H.R.6154), Cryptocurrency Tax Reform Act (H.R.5083), and Cryptocurrency Tax Clarity Act (H.R.5082). Collectively, these bills call for the regulation of cryptocurrencies as it relates to taxing and the classification of cryptocurrencies for tax purposes. Additionally, (in part) these bills would designate the Commodity Futures Trading Commission as the primary regulator of crypto commodities. With a current trajectory towards centralized trading platforms, if passed, these pieces of legislation would act as the hallmark for crypto regulation, reigning in what many believe to be a market with a need to be moderated.