It is without question that 2020 was a bang-bang year for crypto investors. Many generated a substantial amount of short-term capital gains. And with the IRS making clear that cryptocurrencies are “property” for tax purposes, not true currency, this put the spotlight on the taxability of crypto transfers or liquidations. Commonly, the question arises about how to reduce large capital gains tax on crypto transactions. There are a variety of strategies to reduce taxability, including gifting and other tax deferral methods, but one opportunity arises under IRC 4100Z-2. IRC 4100Z-2 describes Federal Opportunity Zones. Taxpayers who generated such gains in 2020 (including gains in 2019 recognized on or after Oct. 5, 2019) can invest those gains into a Qualified Opportunity Fund (QOF) as late as until March 31, 2021 and still qualify for favorable tax treatment. The time to invest is longer for gains recognized in partnerships, S Corps and non-grantor trusts, as late as Sept. 10, 2021. There are three key benefits investing in QOFs:
- Deferment. Cap gains deferred until the later of: (i) the time that the amounts are withdrawn or otherwise triggered under the “inclusion event” rules or (ii) Dec. 31, 2026.
- Lower Cap Gains. After holding the QOF interest at least five years, the taxpayer’s basis in the QOF is increased by 10% of the original amount invested.
- Post-reinvestment Appreciation Exclusion. Taxpayers holding the QOF investment for at least ten years can exclude 100 percent of the post-reinvestment appreciation in the QOF and in the underlying assets held by the QOF — including any eligible qualified opportunity zone business (QOZB) into which the QOF invests.
While it takes patience to employ the QOF tax strategy, it is something that crypto investors with large capital gains should consider. It is a nice option to have in your tax tool kit.