This post was originally posted on Forbes by Shehan Chandrasekera on April 20th, 2020
The Tax Cuts and Jobs Act (TCJA) of 2017 introduced one of the greatest tax saving provisions in the history of the US tax code - Opportunity Zones. Opportunity Zones allow you to defer, reduce and in some cases completely eliminate capital gain taxes on “property”. Since cryptocurrencies are treated as “property” per IRS Notice 2014-21, you can take advantage of this tax provision and significantly reduce your crypto tax bill. In this post we will discuss what Opportunity Zones are, how they work and what kind of tax savings they offer for crypto holders.
What are Opportunity Zones?
Opportunity Zones (OZs) are geographical areas spread across the US designated by state and federal governments for economic development. OZs were introduced by TCJA 2017 and the goal of this provision was to encourage wealthy individuals to invest their unrealized capital gains in these economically distressed areas in a tax efficient manner. In practice, funds are established to pool money from wealthy individuals. Then, these funds, known as Qualified Opportunity Funds (QOFs), invest pooled money directly in development projects in OZs.
How to Use OZs to Reduce Your Crypto Taxes?
Let’s say you purchased 1,000 bitcoin (BTC) in 2013 at an average price of $100 a coin. At the time of this posting, 1 BTC is worth roughly $7,000. Therefore, you would be sitting on $6.9M (($7,000 - $100) * 1,000)) of long term capital gains. If you were to sell your position and cash out, you would be subject to a 23.8% tax rate (20% capital gain tax plus 3.8% net investment income tax). This would result in $1,642,200 ($6.9M * 23.8%) of taxes.
Here is how you can use OZs to save on this huge tax bill. If you are sitting on a large amount of unrealized cryptocurrency gains (there is no limit) as shown in the scenario above, you can enable OZ tax savings by investing the profits directly in a QOF within 180 days of selling your position.
Tax savings come in three forms: tax deferral, tax reduction, and tax elimination. The type of tax relief primarily depends on how long you keep your investment in the QOF.
First and foremost, if you were to properly roll over your $6.9M crypto profit to a QOF, you can defer paying taxes on this until December 31, 2026 or when you sell the QOF position, whichever comes earlier. Therefore, you get to keep $1,642,200 of cash in hand for much longer.
At 5 Years
If you were to hold your investment in the QOF for at least 5 years, 10% of your initial crypto tax gain $690,000 ($6.9M * 10%) will be tax free resulting in a tax savings of $164,220 ($690,000 * 23.8%).
At 7 Years
If you were to hold your investment in the QOF for at least 7 years, an additional 5% of your initial crypto tax gain, $345,000 ($6.9M * 5%), will be tax sheltered resulting in a total tax savings of $246,330 (($345,000 * 23.8%) + $164,220) at year 7.
Note: On this year, you will have to pay taxes on 85% of your initial crypto gain. But, by now, you have deferred paying taxes by 7 years, received a 15% discount on taxes and most likely the fair market value of the QOF you invested on year zero has significantly increased.
At 10 Years
Finally, if you were to hold your investment in the QOF for 10 years, you can completely avoid capital gains taxes on the appreciation of QOF stocks in addition to saving $246,330 of taxes on your rolled over crypto profits. This ability to completely eliminate taxes on the appreciation of QOF stock is the biggest tax saving opportunity of this tax provision.
Note that investing in QOFs is an advanced tax planning strategy, and generally well suited for sophisticated taxpayers with a net worth of at least $500,000. If you are sitting on significantly appreciated cryptocurrency assets, investing in OZs is a great way to save on taxes and diversify your investment portfolio.
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Disclaimer: this post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.