Imagine that you’ve earned a $3 million return from your Bitcoin investments. You exit the investment while the market is high and hold onto your earnings while you look for your next investment. But, instead of simply reinvesting your gains into another high-performing asset, what if you could instead funnel your earnings into a high-performing asset that could help reduce your tax liability on your $3 million gain – and even allow you to earn capital gains tax-free for the next decade?
Now imagine that you missed the boat on the investment window that could have maximized tax advantages by less than two weeks. And, that timing error has cost you several thousands in taxes.
That very thing actually happened to a cryptocurrency investor. He discovered the Opportunity Fund, which offers significant tax incentives for capital gains earned from several investment vehicles — including cryptocurrency, but unfortunately, his discovery came 13 days past the 180-day reinvestment window. Due to that unfortunate timing, he isn’t able to access capital gain tax deferment and reduction incentives under an Opportunity Fund for those capital gains, and his options for protecting his gains are more limited.
But, this isn’t an isolated incident. In 2017, cryptocurrency market capitalization grew by nearly $600 billion, from $17.7 billion to $612.9 billion. That’s a growth rate of more than 34x marketwide, which has left many cryptocurrency investors with significant capital gains, but few tax-advantaged ways to realize them.
On top of that, and unfortunately for cryptocurrency investors, gains from cryptocurrency investments can be inadvertently realized far more often than would be the case with other investments. Due to that, tax efficient ways to turn cryptocurrency into cash are at a premium — and Opportunity Funds may offer a useful way do so, in addition to providing appreciable tax protections.
Cryptocurrency Taxation: Certainties and Uncertainties
Unlike stocks or bonds, cryptocurrency can be used to pay for goods and services, which means that cryptocurrency investments may trigger more taxable events than investors realize. Due to this, many investors may have been underestimating their tax liabilities under the assumption that they realize a gain only when they sell their cryptocurrency investments directly. According to the IRS, anytime a cryptocurrency, such as Bitcoin, is used to purchase goods or services or when an investor sells their cryptocurrency holdings directly, they realize a capital gain, which is subject to a capital gain tax.
And, the IRS has demonstrated that they’re cracking down on cryptocurrency tax evaders more aggressively than they have in the past.
Cryptocurrency is classified as property by the IRS, which has led many to assume that cryptocurrency may get access to some capital gains tax advantages that other types of property receive, such as eligibility for the 1031 Exchange. But in 2017, the Tax Cuts and Jobs Act explicitly limited the 1031 Exchange to real estate transactions and the IRS has not yet provided further guidance on exchanges of cryptocurrencies, and the timing of future guidance is unknown.
Options for cryptocurrency investors to protect their gains have been slim to nil since the creation of the first mass-scale cryptocurrency, Bitcoin, in 2009. However, that changed with the the creation of the Opportunity Zone program under the Tax Cuts and Jobs Act.
Realizing Cryptocurrency Gains: What Tax Incentives Can You Get?
Starting in 2018, capital gains can be invested into a new tax-advantaged investment vehicle: Opportunity Funds. Opportunity Funds offer investors a powerful way to reduce the tax burden placed on capital gains earned from many different asset classes – stocks, bonds, real estate, and cryptocurrency, among others.
But why are Opportunity Funds able to offer such sweeping tax protections for capital gains? Simply put: That’s exactly what the Opportunity Zone program was intentionally designed to do on the investor side.
The Tax Cuts and Jobs Act of 2017 established the Opportunity Zone program to create investment models that would encourage private investors to transfer their unrealized capital gains into funds that support the development of low-income areas across the country.
Instead of dedicating taxpayer money to developing these economically diestressed areas, this policy aims to stimulate investment of $6.1 trillion in unrealized private gains currently held in the US. In exchange for investing in communities within Qualified Opportunity Zones, investors can access capital gains tax incentives both immediately and over the long term.
Opportunity Zone investments offer several significant tax incentives designed to reduce tax burdens and boost investors’ after-tax return potential:
- Investors can defer capital gains earned from many investment types – including cryptocurrency – until December 31, 2026 by investing those capital gains in an Opportunity Fund. If you sell your investment before then, capital gains will become taxable the year that they’re sold. With this option, you get to hold onto your capital gains longer and boost earning potential dramatically compared with what you would have been able to earn had you been held liable for capital gains tax on your gains in the same year that they were recognized.
- Investors who hold their Opportunity Fund investment for a minimum of five years prior to December 31, 2026 can reduce their tax liability on the deferred capital gain principal invested in the Opportunity Fund by 10%. If the investment is held for a minimum of seven years prior to December 31, 2026, tax liability can be reduced by 15% total.
- Capital gains earned from Opportunity Fund investments held for a minimum of ten years can qualify for permanent exclusion from capital gains tax. This means that after the ten-year mark, investors can expect to pay zero capital gains tax on any appreciation from their Opportunity Fund investment whenever they realize gains.
These tax incentives offered through Opportunity Funds make them one of the most powerful tools available to improve tax treatment for many types of capital gains. But for cryptocurrency investors in particular — whose investments may have appreciated in value more than 1,000% in 2017 alone — this may be the single best option for realizing and protecting gains for the next decade — or longer.
With that said, it’s important to note that Opportunity Funds come with a timetable that investors must follow in order to maximize tax advantages.
How to Roll Over Realized Cryptocurrency Gains into an Opportunity Fund
So, how exactly do you get access to improved tax treatment for your cryptocurrency gains? Fortunately, the Opportunity Zone program is designed to reduce red tape and encourage investment:
- Invest realized capital gains into a Qualified Opportunity Fund within 180 days of recognition. No intermediary is required. For example, you can access Fundrise’s Opportunity Fund directly here.
- Indicate that you’ve rolled over your capital gains into a Qualified Opportunity Fund on your income tax return for the year in which you made the investment. An IRS Form 8949 is required.
- Pay deferred capital gains taxes (which may have been reduced) when they become due. This could be as late as April 2027 for investments held through December 31, 2026.
- Potentially pay zero capital gains tax on any appreciation in your Opportunity Fund investment, if you hold that investment for at least ten years. If you hold the investment for less than ten years, you can expect to incur a tax liability on any gains.
Let’s look at each component a little more in depth.
First, investors must invest their realized capital gains into a Qualified Opportunity Fund. Unlike a 1031 Exchange, no intermediary is required for this transaction. This feature can speed up the investment timeline and reduce any potential for bottlenecks within the 180-day reinvestment window. On top of reducing friction, the streamlined process also can reduce costs and fees for Opportunity Fund investors.
Secondly, in order to claim any tax incentives, investors only need to self-report on their income tax return that they’ve reinvested their realized gain into an Opportunity Fund. An IRS Form 8949 is required for capital gains reporting on income tax returns for individuals. This process removes a great deal of reporting burden from the shoulders of the investor, and leaves the fund’s manager fully responsible for correctly selecting qualified investments in Qualified Opportunity Zones.
There are strict limits on what an Opportunity Fund can invest in, which impacts whether an Opportunity Fund is qualified or not. Due to the onus that’s put upon the fund manager rather than the investor, it’s incumbent upon the investor to research their options and choose an experienced and trustworthy Opportunity Fund manager capable of meeting the requirements of the Opportunity Zone program while maximizing returns for investors.
Thirdly, an investor is required to pay their deferred capital gains taxes when they are due. If an investor invests by December 31, 2019 and holds such investment for a minimum of seven years prior to December 31, 2026, such investor can expect to reduce their tax liability for the deferred gains by 15%, and they can expect that payment to be due in April 2027 (unless they divest their investment before then).
Lastly, when an investor exits their investment, they may or may not expect to owe any capital gains, depending on how long they’ve held their Opportunity Fund investment. Investors who hold their investment for ten years or longer can expect to owe no additional capital gains tax for this investment when they cash out. Those who exit their investment before the ten-year mark will miss out on the tax exclusion of capital gains earned from an Opportunity Fund.
Putting Cryptocurrency and Real Estate Together
As previously mentioned, Opportunity Funds are limited in how they invest: at least 90% of their holdings must be invested in Qualified Opportunity Zones. This can be done using only three investment types: partnership interests in businesses operating in Opportunity Zones, stock ownership in businesses operating in Opportunity Zones, and property physically located in Opportunity Zones. We believe that real estate in particular represents a way for investors to preserve and build their wealth while also supporting revitalization projects in burgeoning neighborhoods.
While Opportunity Funds are limited in what they can invest in, there are currently few limitations on the types of capital gains that can be invested in Opportunity Funds. Gains realized from the divestment of stocks, bonds, real estate, 1031 exchanges and cryptocurrencies can all potentially qualify, so long as those gains are rolled over within the mandated 180-day investment window.
As the first real estate investment platform to create a simple, low cost way for anyone to invest in real estate, Fundrise has a history of embracing new investment structures that offer the promise of lower fees and higher net returns for our investors. Our adoption of the Opportunity Fund investment model gives our investors a useful tool to protect capital gains earned from several types of investments by rolling them into real estate investments held within our Fundrise Opportunity Fund.
On top of protecting gains, the new Fundrise Opportunity Fund also offers a way to trade one alternative investment for another – preserving or strengthening portfolio diversification – without incurring a tax liability. By gaining exposure to a variety of types of real estate in communities with strong growth potential, investors can improve the overall composition of their portfolios, without the enormous tax bill that would typically come with extensive rebalancing.
The after-tax return benefits of rolling over appreciated cryptocurrency (or other) capital gains into an Opportunity Fund could immense immediately and over the long term. Are you curious what your after-tax returns might look like if you invest in a Fundrise Opportunity Fund? Use this calculator to see what your potential after-tax returns could be.