Armanino Blog

Crypto Tax Solutions In Light of the Recent IRS Guidance

by David Sordello
October 22, 2019

With the IRS now fully engaged in collecting what they believe they’re owed on past, present and future crypto transactions, it’s time to start thinking of ways to mitigate the burden. Let’s first review the highlights from the recent guidance, and then walk through two specific areas where you or your client can reduce taxes on crypto gains.

On October 9, the IRS released additional guidance on cryptocurrency (see Rev. Rul. 2019-24 and their Frequently Asked Questions on Virtual Currency Transactions). This was the first guidance in over 5 years. These are the highlights:

Retroactive Guidance

Although not explicitly stated, the guidance should be considered retroactive, which means tax payers most likely should be thinking about the process of amending their tax returns.

Forks, Airdrops and Defining “Receive”

Rev. Rul. 2019-24 specifically discussed forks and airdrops and when the taxable event occurs. A fork in and of itself is not a taxable event. However, if after a fork, new crypto is created and received, then that is a taxable event.

The ruling defines “receive” as dominion and control and at the point in time when the taxpayer has the ability to dispose of an airdropped cryptocurrency. But “dominion and control,” including under the IRS’s own policy, generally requires more than the mere ability to dispose of unsolicited property, so this will be an area demanding additional guidance.

Tax Basis Methodology

The Q&A made clear that basis methodology could be either specific identification or FIFO, but if the former methodology is used, then the taxpayer has the burden of keeping accurate supportable records including the time/date at which crypto was bought and sold.

Donating Crypto

Crypto is property for charitable donation purposes. Thus, no income, gain or loss is recognized when donated. The charitable organization gets carryover basis and the donor’s holding period counts for the donee’s holding period.

Also, if the donated crypto was held for more than a year, the deduction would be measured at its fair market value (FMV). Alternatively, if the donated crypto was held less than a year, the deduction would be the cost of the crypto when it was acquired.

How to Reduce Taxes on Crypto Gains

Here are two ways to use the new guidance to support optimal tax planning strategies.

Basis Tracking Optimization

The bottom line is that the IRS is going to pursue collecting its tax (see the IRS Letters 6173, 6174 and 6174-A and the IRS CP2000 Notices), and if you or your client didn’t properly report crypto gains and losses on previously filed returns, you or your client should amend. (Before panicking, know that we are here to help identify and track the highest basis for any past sales, via the specific identification method. If supporting specific identification isn’t possible, we can help you or your client calculate the gains via the FIFO method.)

Opportunity Zones Investing

If you or your client is currently sitting on appreciated crypto, one major way to benefit is to take the unrealized gain and either invest all of it or hedge the appreciation by taking advantage of IRC Section 1400Z-2, more commonly known as opportunity zones investing.

The benefits of opportunity zones investing could be huge. Some are calling it a once-in-a-generation wealth event.

Although there are nuances and specific rules that need to be carefully followed, this example of an in-the-money crypto investor articulates how the program works.

  1. You have unsold bitcoin that has appreciated by $1M.
  2. You decide to take advantage of IRC Section 1400Z-2 and sell 50% of your bitcoin to hedge your $1M of appreciation.
  3. By the end of the year (2019) you invest the $500K in what’s called a Qualified Opportunity Fund (QOF). As of today, there are currently over 150 QOFs.
  4. You file your 2019 tax return in 2020 but do not pay any federal tax on the $500K realized gain (i.e., a federal tax deferral of $119K).
  5. If the investment stays in the QOF for 5 years, your tax is deferred for all 5 years and then also reduced by 10% (i.e., instead of paying $119K with your 2024 tax return, you would only pay $107K).
  6. If the investment stays in the QOF for 7 years, your tax remains deferred and you get an additional 5% reduction in the tax (i.e., instead of paying the $119K with your 2026 tax return, you will now only have to pay $101K).
  7. In 2027 you file your 2026 return paying the $101K of federal tax on the 2019 deferred gain (i.e., the program allows for a deferral until the end of 2026).
  8. You continue to let your QOF investment grow for another 3 years, for a total investing period of 10 years.
  9. Meanwhile your QOF investment has appreciated 7.25% year over year (assumption), resulting in greater than $1M FMV from your original $500K.
  10. The gains from the appreciation of the initial investment are entirely tax free. In other words, at the end of the 10 years of investing in the QOF you receive your $1M not owing a dollar of federal capital tax!

If you’d like to discuss a specific tax situation with one of our experts, don’t hesitate to reach out to the following:

David Sordello, CPA
Head of Tax
Nick Gibbons, CPA
Tax Director

October 22, 2019

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