How spot bitcoin ETFs miss out on major tax alpha

Traditional investors have long viewed the approval of spot bitcoin ETFs as a kind of holy grail for crypto investing. When these products finally launched in early 2024, billions of dollars flowed into the ETFs, which offered a familiar, regulated wrapper for an asset class that had long been seen as anything but.

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But in the two years since, the tradeoffs of the ETF route have become clear. As financial advisors navigate the 2026 tax season, many are discovering that the “perfect” solution has some expensive imperfections. While the ETF solved the custody puzzle for the masses, it also stripped the asset of its most powerful tax advantage.

For advisors, the decision between spot ETFs and direct ownership is not a binary choice between “easy” and “hard” but rather a question of suitability, tax management and risk mitigation.

The “loophole” that survived

The biggest differentiator between the two ownership methods is the survival of the so-called “wash sale rule loophole.” Despite years of legislative threats, the IRS currently still classifies cryptocurrency as property rather than a security.

That distinction is critical. The wash sale rule, which prohibits investors from claiming a tax deduction on a security sold at a loss if they repurchase a substantially identical one within 30 days, does not apply to direct bitcoin holdings.

For advisors managing taxable accounts, this structural difference offers a massive advantage. By harvesting losses during volatility, they can immediately repurchase the asset to maintain exposure.

Consider a client who bought at bitcoin’s October highs: Utilizing direct ownership, an advisor could capture that roughly 28% drawdown as a realized tax loss, then instantly buy back in to catch any recovery. This effectively resets the cost basis while keeping the client fully invested, a maneuver that is strictly prohibited with an ETF.

Clients who rushed into spot ETFs two years ago are discovering they have lost this agility. Because ETFs are regulated securities, they are subject to the standard 30-day wash sale window.

For crypto-savvy advisors like Jirayr Kembikian, co-founder of San Francisco-based Citrine Capital, such differences diminish the value of popular spot ETF options.

“We’ve been incorporating bitcoin into client portfolios since 2020, unless a client opted out,” Kembikian said. “We generally view direct spot bitcoin ownership as the superior form of ownership, while recognizing that every custody method involves tradeoffs. Spot bitcoin ETFs are a great way to start gaining exposure and are easy from an estate or inheritance perspective, but they give up direct control and tax-loss harvesting opportunities.”

A warning on strategy

While the ability to bypass the wash sale rule remains a powerful tool for direct holders, experts warn that the strategy is not a free pass for reckless trading.

Tyrone Ross, CEO of 401 Financial and Turnqey Labs, said that leveraging the tax difference requires a careful approach.

“When done properly, it’s legitimate tax management, not a loophole,” Ross said. “That said, it requires accurate tracking and documentation, and advisors and CPAs should be aware of the economic substance doctrine as it’s not as simple as selling and buying it right back.”

The doctrine dictates that for a tax benefit to be legal, the underlying transaction must have a genuine business purpose or meaningfully change the investor’s economic position — apart from just the tax savings. Essentially, an investor cannot engineer a trade purely to manufacture a deduction; if the move doesn’t carry real market risk or a potential for profit, the IRS can disallow the write-off even if no specific regulation (like the wash sale rule) explicitly forbids it.

For advisors, this creates a distinct divide in client suitability. High net worth clients who can benefit from aggressive tax-loss harvesting may find the operational complexity of direct ownership worth the effort. For others, the risks of improper execution may outweigh the rewards.

ETFs and direct holdings beyond taxes

Beyond tax strategies, experts say the choice between the two ownership methods is not a question of superiority, but of suitability.

“ETFs work well for clients who want simple exposure inside traditional brokerage and retirement accounts,” Ross said. “Direct ownership becomes more appropriate as allocations grow, time horizons extend, and tax and custody considerations matter more. At 401 Financial, we tend to prefer direct ownership.”

Direct ownership is better suited for high net worth and ultrahigh net worth clients, long-term investors and those requiring specific tax flexibility or gifting options, Ross added.

ETFs, on the other hand, can be particularly favorable for clients with smaller allocations and those who value convenience, streamlined reporting and security.

According to Kembikian, ETFs remain the superior vehicle for inheritance and estate planning purposes. Passing down a brokerage account avoids the potential risk of a beneficiary mishandling private keys, a major factor for clients prioritizing peace of mind.

Different vehicles for different clients

There’s no one-size-fits-all answer when it comes to investing in cryptocurrency, advisors say.

For a client with a modest portfolio seeking a minor allocation, the ETF is the prudent recommendation. But for a multimillion-dollar portfolio, direct holdings may be worth the added complexity. And the ownership decisions don’t stop there.

“Direct ownership exists on a spectrum. We generally recommend not holding bitcoin on an exchange, particularly on platforms that are not bitcoin-only, as that significantly increases counterparty and operational risk,” Kembikian said. “Self-custody setups range from single-signature wallets to more advanced multisignature setups, both with and without the use of third-party institutions.

“The right approach depends on the client’s goals, technical comfort and financial situation,” he added. “Our role is to align the custody method with those factors rather than force a single solution.”