The value of cryptocurrencies and other digital assets has skyrocketed over the past few years. If you’re a crypto investor with big capital gains, you may want to lock them in by diversifying them into other areas, such as real estate. Particularly, in a relatively new program called Qualified Opportunity Zones (QOZs). The potential tax benefits attached to this fund type can be an effective and tax-efficient way for you to diversify your portfolio with real estate.
This article discusses how cryptocurrency gains are taxed and how investors can reinvest their capital gains from the sale(s) of their digital currencies, such as bitcoin and Ethereum, or even Non-Fungible Tokens (NFTS) into Qualified Opportunity Zone Funds.
How is Crypto Taxed?
Like publicly traded stock, cryptocurrency is taxed as property under Federal income tax law. Depending on the situation, the sale of it can trigger a long-term capital gain or loss, short-term capital gain or loss, or ordinary income.
How the crypto or NFT was acquired, and how long it was held, will ultimately determine how the gain or loss on sale will be taxed for Federal income tax purposes. There are many state implications for the taxation of cryptocurrency and investing in real estate, but those topics are not covered in this article.
Acquiring Cryptocurrency as an Investor
An investor who purchases cryptocurrency as an investment will not have a taxable event until they decide to sell the assets or use the assets to purchase goods or services. Once the digital asset is sold or spent, the investor will look to the holding period to determine how to treat the gain or loss for income tax purposes.
If the investor holds the asset for more than a year, the gain or loss will be treated as a long-term capital gain or loss. If the investor holds the cryptocurrency for less than a year, the gain or loss will be treated as a short-term capital gain or loss.
Receiving Cryptocurrency for Goods or Services
If an individual owns a company, and a customer pays the individual with cryptocurrency, this transaction will be reported and taxed as ordinary income. For example, if a law firm receives one bitcoin in exchange for legal work performed, the law firm will include the fair market value of the bitcoin received as revenue to the law firm. Regardless of whether the received bitcoin was then sold, the law firm will be required to report the revenue as ordinary income for tax purposes.
Mining cryptocurrency is treated as ordinary income for tax purposes. The fair market value of the cryptocurrency will be included in a taxpayer’s annual income on the date a taxpayer successfully mines the cryptocurrency.
Made a Big Gain Selling Crypto or an NFT? Reinvest Those Gains in an Opportunity Zone to Diversify Your Portfolio
If an investor has a capital gain from the sale of their crypto or NFT, they might be looking to defer paying tax on the gain.
Many cryptocurrency investors may not be aware of the QOZ program that was created in 2017 as part of the Tax Cuts and Jobs Act. The purpose of the program is to allow investors to cash out of other investments and re-invest the capital gains into real estate projects that are targeting areas of the United States which have traditionally been underfunded.
Only capital gains can be reinvested into Qualified Opportunity Zones, so if your cryptocurrency transactions will be taxed as ordinary income this program will not provide tax benefits to you.
By investing your capital gains into underfunded areas of the country, you are allowed to defer the recognition of the invested capital gain for tax purposes until you choose to sell the investment, or until December 31, 2026, whichever occurs first.
In addition, if the investment is held for at least 10 years, the growth of the investment in the Opportunity Zone Fund will be completely excluded from federal income taxes, as the basis is stepped up to the current fair market value. An investment into a Qualified Opportunity Zone Fund must be made within 180 days after the capital gain is recognized.
Qualified Opportunity Zone Fund Example
Here is an example of how an investment into a QOZF works:
- $100,000 worth of cryptocurrency was purchased five years ago
- All of it is sold today for $1,000,000 resulting in a $900,000 taxable gain
- If the investor reinvests the $900,000 within 180 days into a QOZF, no Federal income tax will be due until the investment is sold or until April 15, 2027.
- In 10 years the $900,000 investment grows to be worth $2,500,000. The $1,600,000 of appreciation is permanently excluded from federal taxes as the asset was held for at least 10 years.
We recommend you consult with a tax advisor regarding both the sale of cryptocurrency and the investment into Qualified Opportunity Zone Funds.
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