Constructive Selling Could Trigger Crypto Taxes Without You Even Selling
The recently released final text of the Reconciliation Bill (SEC.138151) aims to subject cryptocurrency to a complex tax rule called a constructive sale. Under this proposed rule which could take effect on January 1, 2022, cryptocurrency users could pay taxes without even selling their crypto positions.
What is a constructive sale?
Before we talk about constructive sales, it’s important to understand the default tax rules for reporting cryptocurrency gains. Typically, crypto gains are not taxed until they are realized. You make capital gains in cryptocurrency when you withdraw or convert one coin to another.
However, a constructive sale can happen even if you don’t actually exchange your parts. This happens when you have an Appreciated Financial Position (AFP) and enter an “essentially identical” asset offset position through an option, futures or futures contract to reduce the risk of losing money. money in the long position.
For example, let’s say Tom bought 1 bitcoin (BTC) for $ 10,000 on January 15, 2020. On September 27, 2021, he’s worth $ 50,000, so he’s in good financial standing. On this date, Tom is worried that the price of BTC will drop below $ 50,000. To reduce the risk of losing money, he buys a put option to sell BTC at $ 45,000. This put option contract gives Tom the right to sell (or short) 1 BTC at $ 45,000 even if the prices fall below $ 45,000. If the price of BTC exceeds $ 50,000, it can still profit from selling the long position. Thus, these two offset positions lock his gains.
Taxation on constructive cryptocurrency sales
Capital gains taxes
An implied sell occurs as soon as Tom buys a BTC short put option on September 27, 2021. The rule requires you to report your income and pay taxes. as if the long position was actually sold. Why? According to the tax code, you indirectly sold your position by buying an offsetting position.
Therefore, Tom must report a capital gain of $ 40,000 ($ 50,000 – $ 10,000).
(A constructive purchase is also possible when you buy a coin while having a popular short position on a substantially identical coin)
Adjustment of the cost base
Next, Tom will need to adjust AFP’s cost base by the amount of the gain recognized. Therefore, the updated cost base of the original BTC position will be $ 50,000 ($ 10,000 + $ 40,000).
Resetting the capital gains clock
Additionally, the implied sell resets the capital gains clock of the original long position. A new holding period starts on September 27, 2021 for BTCs purchased on January 15, 2020.
Being subject to the implied selling rule is bad because it forces you to report earnings and pay taxes without actually receiving any money. Also, since it resets the holding period, you will have to wait longer to subject future gains to favorable long-term capital gains tax rates.
Closed transaction exception
Fortunately, you can get around the rule of implied selling if you plan the transactions correctly.
You can ignore the implied sale if all of the following are true:
- You closed the short position in the tax year or at the end of the 30th day after the end of your tax year.
- You have held the appreciated financial position for at least 60 days from the day you closed the short position.
- Your risk of loss was not reduced at any time during this 60 day period by holding certain other positions.
Continuing with the example above, let’s say that Tom closed the short position on January 15, 2022. He continued to hold the original long position (1 BTC bought on January 15, 2020) at least until March 15. 2022 (60 days from January 15, 2022). In addition, he did not initiate any other offsetting position to reduce his risk from January 15, 2022 to March 15, 2022. Here, Tom has fulfilled all three requirements. He can safely ignore the implied sale statement ($ 40,000) on his 2021 tax return.
Ambiguity and administrative burden on taxpayers
The implied sell rule only applies when you buy an “essentially identical” offset position. What is “essentially the same” is not clearly defined in the tax code and is based on the facts and circumstances of each case. This can lead to confusion and inaccuracies. For example, it is reasonable to think that having a long position in BTC and a short position in wrapped bitcoin (wBTC) would result in a constructive sell because they are substantially the same. However, whether going long in BTC and short selling Grayscale Bitcoin Trust (GBTC) units is a constructive sale or not is subject to interpretation.
It will be your responsibility to track constructive sales, adjust the cost base, and report gains, if applicable. Cryptocurrency exchanges will not report constructive sales in their transaction history reports. It is also unlikely to see any constructive sales transactions on the next 1099-B forms. Finally, if passed, this rule along with the wash sale rule will significantly increase the administrative burden for cryptocurrency taxpayers.
Disclaimer: This article is for informational purposes only and does not constitute tax advice. For tax advice, please consult a tax professional.