Tax-loss harvesting

Key takeaways

• Direct crypto vs. ETFs: The IRS classifies crypto as property rather than a security (IRS Notice 2014-21), so direct crypto holdings are not subject to wash sale rules. Spot crypto ETFs structured as grantor trusts may also fall outside the wash sale rule under the grantor trust look-through principle, which treats investors as directly owning the underlying digital asset. 40-Act fund structures, by contrast, are subject to wash sale rules as securities. 
• Managing wash sale risk: To minimize risk, investors could harvest losses by rotating into products with different economic exposures (e.g., from a single-asset ETF to a diversified index ETF). 
• Compliance: Meticulous record-keeping is essential due to increasing IRS scrutiny on all digital asset transactions.
• Consult a tax professional: Tax rules governing crypto and crypto ETFs are evolving, and the right strategy depends on your clients’ specific holdings, filing status, and cost basis. Always consult a qualified tax advisor before executing a tax-loss harvesting strategy involving digital assets.

Tax-loss harvesting means selling a position that has declined in value to realize a capital loss, which can offset capital gains elsewhere in a portfolio, or up to $3,000 of ordinary income per year ($1,500 if married filing separately), with excess losses carried forward (IRC §1211(b); §1212(b)). These mechanics generally apply for crypto. The question that shapes the strategy is what an investor can buy after selling without triggering a wash sales disallowance.

The wash sale rule and why crypto is different (for now)

Under current US tax law, the wash sale rule (IRC §1091) disallows a loss deduction if you buy a "substantially identical" security within 30 days before or after the sale. In traditional asset management, this means selling one index ETF and immediately buying a comparable ETF tracking the same index could disallow the loss deduction, as both may be considered substantially identical.

The wash sale rule currently applies only to securities, not to commodities or digital assets. The IRS has not classified spot crypto as a security, meaning spot crypto positions held directly are not subject to wash sale rules today. An investor can sell Bitcoin at a loss and buy it back the next day — the loss stands.

However, when crypto is wrapped in a fund structure, the analysis changes.

Scenario 1: Swapping a spot Bitcoin ETF for direct Bitcoin (or vice versa)

An investor holds shares of a spot Bitcoin ETF registered under the Securities Act of 1933 (commonly referred to as 33-Act funds), structured as grantor trusts, at a loss and sells them, then purchases Bitcoin directly; or sells spot Bitcoin and buys shares of a Bitcoin ETF with the proceeds.

Under the grantor trust look-through principle, investors in these ETFs may be treated for tax purposes as directly owning their pro rata share of the underlying digital asset.Because the IRS classifies crypto as property rather than a security (IRS Notice 2014-21), swapping between a grantor trust ETF and direct Bitcoin may not trigger a wash sale disallowance. The IRS has not issued definitive guidance on this point. 

That said, investors should be aware of the practical trade-offs: moving from an ETF to direct Bitcoin introduces custody considerations, and the reverse trade (selling spot Bitcoin to buy a Bitcoin ETF) may have tax consequences of its own depending on the cost basis of the Bitcoin being sold. Consult a qualified tax advisor before executing.

Scenario 2: Switching between two spot crypto ETFs

An investor holds a spot Bitcoin ETF from Issuer A and wants to swap into a spot Bitcoin ETF from Issuer B to harvest a loss. Both are 33-Act funds structured as grantor trusts.

Some practitioners take the view that the grantor trust look-through principle applies here: because investors are treated as owning the underlying digital asset directly, and crypto is classified by the IRS as property rather than a security (IRS Notice 2014-21), the wash sale rule under IRC §1091 may not apply to this swap, even where both ETFs hold the same underlying asset. The IRS has not addressed this question directly, and the position remains unsettled.

Given this uncertainty, investors should consult a qualified tax advisor before executing this trade.

Scenario 3: Swapping a spot single-asset ETF for a broad crypto index fund or ETF

An investor sells their spot Bitcoin ETF, a 33-Act fund, at a loss and moves into a broad-based crypto index ETF registered under the Investment Company Act of 1940 (commonly referred to as a 40-Act fund).

A diversified index product with exposure across Bitcoin, Ethereum, Solana, and others is generally considered to present lower wash sale risk than a like-for-like single-asset swap, as the economic exposure is materially different. This approach mirrors the traditional playbook: sell a sector ETF, rotate into a broader index. The wash sale risk here is meaningfully lower, though not zero, and the specific fund compositions matter.

The right approach depends on individual circumstances, but the structural differences outlined above give advisors and investors a clear framework for evaluating each trade before executing.

_{For informational purposes only. 21shares does not provide tax, legal, or accounting advice. Nothing in this article constitutes a recommendation to buy or sell any product. Tax laws and regulatory guidance on digital assets are evolving; readers should verify current rules with a qualified tax advisor.}

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