iIn December 2022, I was quoted in an article in “Tax Notes” by Lee Sheppard to the effect that the wash sales rule in Internal Revenue Code (Code) Section 1091(a) (losses from wash sales of stock or securities) doesn’t apply to the purchase and sale of cryptocurrency.[1] A week later in a letter to the editor, Professor Reuven Avi-Yonah argued my view may be “a trap for the unwary.” He warned that a court is “likely to interpret ‘securities’ in section 1091” as including cryptocurrencies.[2] A week after that, “Tax Notes” published another letter to the editor, this time from Robert Willens, arguing strongly that Professor Avi-Yonah’s concerns about application of the wash sales rule to crypto don’t hold up. Mr. Willens reaffirmed my position that cryptocurrencies are not subject to the wash sales rule.[3]
Apart from this back and forth in “Tax Notes,” there has been a great deal of public discussion as to whether the wash sales rule should apply to cryptocurrency transactions. For example, the proposed 2021 Build Back Better Act would have amended the Code to provide that “digital assets,” including cryptocurrencies, would be subject to the wash sales rule. That bill failed to pass Congress, and when it was substantially reworked to become the Inflation Reduction Act of 2022,[4] signed into law in August 2022, it did not include this amendment. President Biden has included a substantially similar plan for digital assets in his proposed budget for fiscal year 2024.[5] In May, President Biden tweeted out an infographic urging Congress to close “the loopholes” that help wealthy crypto investors avoid taxes.[6] And over the past year or so, the SEC has been increasingly aggressive in characterizing various sorts of digital assets as “securities,” including 46 different cryptocurrencies and digital tokens.
In light of all of the attention being paid to cryptocurrencies and the wash sales rule, it seems like an appropriate time to revisit the issue and try to bring some sense of certainty to the current status of this issue, if not of what the future might bring.
What the Wash Sales Rule Says — And Doesn’t Say
The best place to start is with the statutory language of the wash sales rule itself. Code §1091(a) provides that losses “sustained from the sale or other disposition of shares of stock or securities” (disposition event) are disallowed when the taxpayer has, within 30 days before or after the disposition event, “acquired … or has entered into a contract or option so to acquire substantial identical stock or securities” (acquisition event). This rule applies unless the taxpayer is a dealer in stock or securities.[7] The structure and language of the wash sales rule are essentially unchanged from the predecessor provision adopted in 1920 and amended in 1924. In 1988, however, Code §1091(a) was amended to provide, “For purposes of this section the term ‘stock or securities’ shall … include contracts or options to acquire or sell stock or securities.”
Neither the term “stock” nor “securities” is defined in Code §1091. Where these terms are used elsewhere in the Code, they generally have consistent meanings. “Stock” always refers to shares of stock in an entity taxed as a corporation, and “securities” always refers to notes, bonds, debentures, and other evidences of indebtedness. There are some Code provisions where securities have an expanded meaning. For example, in Code §1236(c), a security is defined for purposes of dealer investment accounts to include, in addition to evidence of indebtedness, “any evidence of an interest in or right to subscribe to or purchase any of the foregoing [i.e., shares of stock or evidence of indebtedness].” Nowhere in the Code, the legislative history of any Code provisions, or IRS or Treasury regulations or advice is the term “stock or securities” defined or used to mean anything other than shares of or interests in stock in a corporation; evidence of indebtedness; or a contract, right, or option with respect to the foregoing items. Thus, if Code §1091 is to be interpreted as applying to cryptocurrencies, it must be done other than through traditional statutory analysis.
Given the lack of support for the view that cryptocurrency is subject to the wash sales rule, Professor Avi-Yonah seems to concede that based on a literal reading of Code §1091, cryptocurrencies are not subject to the rule. Instead, he makes two arguments to support his claim that a court is “likely” to interpret the term “securities” in the wash sales rule to include cryptocurrencies.
Arguments for Subjecting Cryptocurrencies to the Wash Sales Rule
Professor Avi-Yonah’s first argument is that unlike Code §1091, Code §1092 (the straddle rules) applies to “positions” not “stock or securities” and, therefore, Code §1091 “likely includes all crypto.” According to Avi-Yonah, courts have interpreted “securities” so as to accomplish the “purpose” of the Code section where the term is used. As a result, he argues that a court is “likely to interpret ‘securities’ in Code §1091 as similar to ‘positions’ in Code §1092 because not applying the wash sales rule to crypto would defeat the purpose of the rule. Such a reading would prevent taxpayers from harvesting losses while maintaining their economic interest in the property sold.” This argument suggests that courts can and should interpret statutory language contrary to its clear meaning if they believe it is necessary to accomplish the “purpose” of the statute. I believe this argument is wrong as a matter of both law and fact.
A case in point is Gantner v. Comm’r, a U.S. Tax Court decision affirmed by the Eighth Circuit.[8] Prior to the 1988 amendment to Code §1091, the taxpayer in this case purchased and sold a large quantity of stock options within the 61-day wash sale period. He took a deduction for the loss, which the IRS disallowed on the grounds that stock options are securities for purposes of Code §1091, and thus are subject to loss disallowance under the wash sales rule.
The Tax Court found the issue to be “one of first impression.” Employing the “cardinal rule of statutory construction,” namely that “effect shall ‘be given to any clause and part of a statute,’” the Tax Court held that a disposition event applied to “stock or securities,” while an acquisition event also applied to “a contract or option to acquire substantially identical stock or securities.” Thus, according to the Tax Court, “the plain meaning of section 1091(a) is that an option to acquire stock is not equivalent to ‘stock or securities,’ and a loss sustained from a sale or disposition of stock options is not a loss which comes within the plain meaning of section 1091.” Despite its finding that on its face Code §1091(a) did not apply to losses on the disposition of options, the Court went on to examine the legislative history to determine whether the intent of Congress in adopting the wash sales rule was contrary to a straightforward reading of the statute. The Tax Court found that “it is clear” that Congress “certainly did not contemplate the application of [the predecessor of Code §1091] to losses on sale of options.” The Court surmised that the absence of a ready resale market for stock options in 1921 and 1924, when the wash sales rule was first added to the Code, explained why Congress did not include such options in the disposition event component of the wash sales rule. Despite obvious evidence that Congress was aware of the growth of the options market, Congress did not attempt to bring options into Code §1091, given its amendment of the Securities Act of 1933 and the Securities Exchange Act of 1934 to explicitly include put and call options within the definition of “security.” As a result, the Tax Court concluded, “Congress had never intended for losses on sales of stock options to be subject to disallowances under the statutory wash sales provision of section 1091.”
Two Key Points Why Not to Include Crypto in Wash Sales Rule
Two things about the Gantner case are particularly relevant to the question of whether the wash sales rule applies to cryptocurrency. First, at no point did the Tax Court (or the Eighth Circuit) consider whether the wash sales rule should apply to options on a disposition event to, in Avi-Yonah’s words, otherwise “defeat the purpose of the rule.” Statutory construction is a matter of interpreting the language of a statute in light of its legislative history. Because there is no suggestion in the language of Code §1091 or its legislative history that cryptocurrency is to be included in its coverage, there is no legal justification for a court to interpret the wash sales rule to include cryptocurrency.
Second, the term “securities” is defined in other Code provisions to include options. Therefore, it is unreasonable to argue that the term “securities” also included options when it was used in Code §1091. With that said, however, at no place in the Code is the term “securities” ever defined to include cryptocurrencies. Therefore, the argument that “securities” should be read to include cryptocurrencies for purposes of the wash sales rule lacks plausibility as being reasonable.
But if the wash sales rule does not apply to purchases and sales of cryptocurrencies, is there any other Code provision that might disallow a taxpayer’s loss on disposition of cryptocurrencies within 30 days of the acquisition of substantially similar property? Professor Avi-Yonah points to Treas. Reg. §1.165-1(b), which provides that “only a bona fide loss is allowable. Substance and not mere form shall govern in determining deductible loss.” According to Avi-Yonah, “I find it hard to imagine that even a textualist judge would determine that … a loss [on the purchase and sale of cryptocurrencies within the 61-day period] is bona fide under the regulation.” But why is it hard to imagine? Indeed, the loss in such a transaction is most certainly “bona fide.” It is evidenced by a closed and completed transaction effected with an unrelated party. It is clearly identified as a closed transaction on a crypto exchange’s records, and it is permanently entered as a completed transaction on a blockchain. I find it hard to imagine how a loss transaction could be any more bona fide.
Where the Wash Sales Rule and Securities Law Sit for Now
The remaining question is whether the SEC’s recent aggressive actions against several crypto exchanges and its declaration that a significant number of cryptocurrencies and digital tokens are “securities” have relevance for the wash sales rule. First, as I have written elsewhere, the increasing variety of digital tokens that represent interests in or ownership of an entity taxed as a corporation may well constitute “stock or securities” for various Code provisions. (See my article about tokens, stock, and taxation.) Unlike some digital tokens, I am unaware of any cryptocurrency that purports to constitute such an ownership interest. If certain digital assets are securities for securities law purposes, they would need to be analyzed to see whether they are “stock or securities” for purposes of Code §1091. Second, the securities laws are the securities laws, and the tax laws are the tax laws. They operate with different definitions, objectives, and structures. There are many things that are securities for purposes of the securities laws — orange groves, franchise arrangements, and futures contracts on broad-based indexes, to name but a few — that are not “stock or securities” for tax law purposes. Third, what the SEC says is a security has no weight or precedential value for determining whether that asset, property, or arrangement constitutes “stock or securities” for tax purposes. The securities laws and tax law are entirely different creatures and never the twain shall meet.
While it is dangerous to be definite about the status of cryptocurrencies for any tax purpose, at this time it is about as certain as anything can be when looking at cryptocurrency that crypto is not subject to the wash sales rule. But just like the weather, tomorrow is another day, and there is no telling what changes the future may bring. We need to stay tuned.
[1] Lee Sheppard, “When Can Hodlers Recognize FTX Losses?” Tax Notes Federal, Dec. 5, 2022, 1323.
[2] Reuven S. Avi-Yonah, “Beware of Crypto Wash Sales,” Letter to the Editor, Tax Notes International, Vol. 108, Dec 12, 2022, 1379.
[3] Robert Willens, “Cryptocurrency Cannot Be The Subject of a Wash Sale,” Letter to the Editor, Tax Notes Federal, Vol. 177, Dec. 19, 2022, 1707.
[4] Inflation Reduction Act of 2022.
[5] President Biden’s proposed budget for the 2024 fiscal year, provision about wash sales on Page 164 of PDF.
[6] Kelly Phillips Erb, “Crypto Investors Scratching Their Heads Over Biden’s $18 Billion Tax Threat Should Look at Wash Sales,” Forbes, May 11, 2023.
[7] Code §1091
[8] Tax Court case
