This article is for people who meet the following two requirements:
- You’re a US person for US tax purposes (i.e., you’re a US citizen, a US green card holder, or a US resident), and
- You buy and sell cryptocurrency.
The (Not So) New World of Crypto
Crypto has sort of taken over the world lately. Since it’s so new, it’s easy to think it’s impossible for the dusty old tax code to keep up.
That’s true in certain respects (mainly reporting gains/losses from trading crypto–discussed more below). But in large part, crypto is really just reminding everyone of the same old tax rules that have been around since the dawn of the US income tax in 1916.
Fundamental tax concepts
We normally think of a taxable event as only occurring when we trade property for cash. For example, when you direct your broker to sell 100 shares of Apple stock, and then those shares leave your brokerage account with cash taking its place, you know that’s a taxable event, generating a gain or loss.
But the actual tax rule at play here is a little different. For tax purposes, you have a gain or loss any time you trade one type of property for another.
So, the reason that selling 100 shares of Apple stock is taxable isn’t because you got cash in the exchange, it’s because you got property that wasn’t Apple stock.
Here’s the real mind-blower: purchasing 100 shares of Apple stock for cash is actually a taxable event as well. Apple stock and cash are different types of property, so in that transaction you’ve sold the cash in exchange for Apple stock.
Now, to determine whether you have a gain or loss on an exchange, you simply determine your “amount realized” (i.e., the value of what you received in the exchange) and your “basis” (i.e., what you paid for what you gave up in the exchange). You have a gain if the amount realized exceeds your basis, and you have a loss if your basis exceeds the amount realized.
Cash always has a fair market value and a basis that is exactly equal–they both equal the face value of the cash. So, when you exchange cash for property, you’ll always have zero gain or loss on the exchange because the amount realized and your basis are the same (the face value of the cash).
Like this article? Click here to stay informed on the latest tax topics for global individuals who live or invest abroad.
Application to Crypto
When you sell crypto for cash, that’s a taxable event. But of course you knew that. The more controversial result is that a trade of one cryptocurrency for another is also a taxable event.
Before 2018, there was some argument that a crypto-to-crypto trade qualified as a “like-kind exchange” under Section 1031 of the Internal Revenue Code and therefore wasn’t immediately taxable. Unfortunately, I don’t think that was a very good argument–two cryptocurrencies probably do not qualify as “like-kind” property with respect to one another. And then, even if they did, it’s not the case that all exchanges of like-kind property are like-kind exchanges under Section 1031–the exchange would have had to qualify for numerous other technical rules to be a like-kind exchange, and you’d have to include some special forms in your return.
In any event, beginning in 2018, Section 1031 only works for exchanges of real property. So, going forward, all crypto-to-crypto exchanges are definitely taxable immediately. And, even worse, you’re required to report each of those trades on your US tax return as a separate line item.
For many people, it’s simply impossible to correctly file your tax return and actually report your crypto trades correctly. Many people simply load up some cash or BTC onto an exchange, trade in and out of various cryptocurrencies on a frequent basis, and are left with some amount of cash and/or crypto at the end of the year.
Reporting all of those trades correctly may require attaching a statement to your tax return. And attaching that statement is absolutely required by the rules–you’re not allowed to simply report everything on a summary basis.
Offshore Company to the Rescue
Trading crypto through an offshore company makes this whole thing so much easier. For frequent traders, it eliminates a ton of headaches, and in extreme cases it’s the only way to really make it possible to file a correct US tax return.
Here’s what an offshore company does for a frequent crypto trader: It turns all of those line items on your tax return for each crypto-to-crypto exchange into one simple line item for income allocated to you from the offshore company (technically called “Subpart F income”). So, instead of having to attach an impossibly long statement to your return, you’ll simply report one item of income.
You’re required to sign your tax return under penalties of perjury, and that’s going to be impossible with dozens or hundreds or thousands of unreported trades. So turning all of that mess into a simple slug of income really makes your life easier.
More detail here:
- “Subpart F income” is simply a type of income earned by a “controlled foreign corporation” (i.e., an offshore company in which US persons own more than 50%). Gain or loss on the sale of cryptocurrency definitely qualifies as subpart F income.
- This reporting benefit is the only US tax benefit to using an offshore company. The offshore company will NOT allow you to pay less tax overall or defer your payment of tax–there’s no legal way to do that.
- Subpart F income is ordinary income, so you should only trade crypto through an offshore company if you’ll trade frequently (i.e., holding each position for less than a year).
- If you have a loss overall, it will be trapped in your offshore company. It won’t be available to offset losses from other sources until you liquidate the offshore company, at which point it will be a capital loss (so you can only use it against capital gain and up to $3,000 of ordinary income each year).
- Trading through an offshore company will require you to include some complicated tax forms in your return, such as IRS Form 5471 and IRS Form 926. You may also be required to file the Foreign Bank Account Report as well if you have accounts at a non-US crypto exchange.
Non-Tax Benefits of an offshore company
Many crypto traders set up offshore companies for the non-tax benefits as well. Some non-US crypto exchanges will not allow a US citizen or US legal entity to open an account, and many ICOs do not allow participation by US persons. Many crypto traders use offshore companies for the purpose of getting around these restrictions.
Additionally, offshore companies can provide a privacy benefit as well. Now that we’ve learned that crypto trading isn’t as private as we once thought, many crypto traders find it nice to have another layer of anonymity between them and the crypto exchange.
setting up an offshore company
Setting up an offshore company can be a little daunting. You’ve got to trust someone in a country you probably have no other experience with, in an industry that’s full of sharks. Then, you have to figure out how to report it all correctly on your US tax return, using some of the most convoluted tax forms known to mankind.
I can help. I have a full package of services to answer all your questions, get everything set up quickly and easily, and make sure it’s all reported correctly for US tax purposes.
To get started, click here to set up a call so we can discuss your particular situation.
Ready to set up your offshore company to trade crypto? Book a call so we can discuss your specific situation and I can answer all your initial questions.