The Qualified Opportunity Zones (QOZ) rules became law under the Tax Cuts and Jobs Act (TCJA) of 2017. These rules are designed to encourage investment and economic growth in specific low-income areas. But there are important things to understand about Qualified Opportunity Zones and cryptocurrency.
Can investors apply the QOZ rules to defer US tax on the gains from the sale of cryptocurrency? To answer that question, let’s start by reviewing how the QOZ rules work.
What are the Tax Benefits of Investing in a QOZ?
- A taxpayer may defer gain from the sale or disposal of a capital asset if the gain is reinvested into a Qualified Opportunity Zone Fund (QOF) within 180 days of the recognition of the sale or disposal.
- The original gain is deferred until the taxpayer sells or exchanges the QOF interest or until December 31, 2026—whichever is earlier.
- If the deferred gain is held within the QOF for at least 5 years, the taxpayer will be able to exempt 10% of the deferred gain from federal tax.
- If the deferred gain is held within the QOF for at least 7 years, the taxpayer will be able to exempt an additional 5% from tax (for a total exemption of 15% of the deferred gain).
- If the taxpayer holds the investment for at least 10 years, the taxpayer will be able to exempt 100% of the post-reinvestment gain from federal tax.
Can Gains from the Sale of Cryptocurrency be Deferred Under QOZ Rules?
For a gain to be deferred under the QOZ rules, the gain must be from the sale or disposal of capital assets. But one of the biggest questions at the time the rules were promulgated was: What qualifies as a capital asset? Specifically, can a taxpayer defer the gain on the sale or disposal of cryptocurrency? Surprisingly, the answer to this question is yes.
Although countries worldwide are still working out the details of what cryptocurrency is—money, a currency equivalent, property, or something else entirely—the IRS has already communicated its view. In guidance issued in 2014, the IRS was clear on this point: cryptocurrency is property for US tax purposes.
As such, cryptocurrency is a capital asset, and the gain from the sale or exchange of cryptocurrency qualifies for deferral under QOZ rules.
Illustration: The Intersection of QOZ and Cryptocurrency
Here is an example of how a capital gain from the sale of cryptocurrency can work in conjunction with a QOZ.
Assume that on December 31, 2019, taxpayer Jane realizes $20 million in long-term capital gains from the sale of bitcoin (a type of cryptocurrency).
Jane conducts due diligence to find the proper QOZ investment. Jane invests the $20 million gain into her selected QOZ fund on June 1, 2020 (within the 180 days of the sale).
Let’s assume that Jane ends up holding the investment for at least 10 years. Jane will have a $2 million exemption (10%) of the original gain on June 1, 2020. Jane will have an additional $1 million exemption (5%) of the original gain on June 1, 2027. Then, Jane will recognize $17 million of the deferred gain (85%) on December 31, 2026—the last date of deferral.
Let’s assume the investment is worth $100 million on June 1, 2030. Jane sells her interest in the QOZ on that day. This sale represents $80 million of post-reinvestment gain. This entire gain is tax-free to Jane.
An Alternative to Like-Kind Exchanges?
As part of TCJA, the IRS limited like-kind exchanges to only real property. While the position is uncertain with the IRS, prior to 2018, many cryptocurrency investors and traders used the like-kind exchange rules to defer the gain for exchanges of cryptocurrencies.
Now that this is no longer an option under TCJA, the QOZ rules may provide an interesting alternative to taxpayers who are looking to cash out of cryptocurrency holdings that are subject to significant capital gains.
Want More Information?
Do you want more information about Qualified Opportunity Zones and cryptocurrency? Curious how a QOZ investment could work in your situation? Our international professionals can model the timeline for actual investment and how it’s presented and tracked on your return through a professional engagement. Call us to schedule an appointment today.
The IRS has published a set of frequently asked questions on this topic.