By Chris Brodersen
Retail investors and financial advisers have much to learn about this new investment
For all its opportunities, bitcoin (BTCUSD) has posed a number of challenges for investors. On top of the inherent difficulties of understanding blockchain terminology and the underlying technology, the challenges of understanding how to convert a fiat currency to cryptocurrency, manage the cryptographic keys and maintain custody of the assets have limited access to this asset class for many retail investors.
The tide turned last January when the U.S. Securities and Exchange Commission approved 11 spot bitcoin exchange-traded funds. The approval of the ETFs was a watershed event that will increase retail investors' access to the asset class. This was evidenced by the historic volumes seen on the first day of trading and by the flows into these ETFs in the subsequent weeks.
One of the many advantages of a bitcoin ETF is that it shifts the burden of custody, tracking, counterparty risk and compliance reporting to the asset manager, removing the burden on retail investors to fully understand the complexities of owning cryptocurrencies. Bitcoin ETFs also provide investment advisers and other institutional investors with exposure to bitcoin funds in a regulated manner, opening up a new asset class to these institutions.
But with many retail investors getting into cryptocurrency for the first time, it's important to be aware of the tax implications of owning bitcoin ETFs.
When you buy
The SEC has indicated that bitcoin ETFs are currently cash-creation only, which means that investors can only purchase them through their broker with cash. My sense is that it's unlikely the SEC will allow in-kind subscriptions (sending bitcoin in exchange for bitcoin ETF shares) for any bitcoin or other crypto ETFs. That isn't allowed for other commodity ETFs, and I don't believe an exception would be made in this case, especially with the SEC's focus on curbing ransomware, money laundering, sanction evasion and terrorist financing as they relate to bitcoin.
If investors already own bitcoin but want instead to own shares of a bitcoin ETF, they will have to sell or swap their bitcoin to generate the cash to purchase the shares. The sale or swap of bitcoin triggers a taxable event, and depending on the basis and holding period, owners and investors will need to recognize a long-term or short-term gain or loss.
When you sell
Selling shares of a bitcoin ETF can result in a taxable event, just like selling bitcoin does. The difference is that since the bitcoin ETF is a security, it is subject to wash-sale rules. A wash sale occurs when you sell stock or securities at a loss and acquire substantially identical stock or securities within 30 days before or after the sale. You do not receive a tax deduction when you trigger a wash sale; the loss is rolled over as additional basis into the stock or security you acquired. Essentially, it's as if you never sold to begin with.
Bitcoin ETFs follow the traditional rules for capital gains and losses. First, short-term capital gains and losses (including carryovers) are netted. Next, long-term capital gains and losses (including carryovers) are netted. Finally, the net short-term gain or loss is combined with the net long-term gain or loss.
Paying taxes
Ownership of a bitcoin ETF is no different from ownership of traditional ETFs: The fund manager is responsible for all trading activities based on their strategy and custody of the assets. An investor will receive a tax statement, Form 1099-B, at the end of the year, simplifying tax reporting for all parties.
Owning shares of a bitcoin ETF reduces the recordkeeping burden for the owner. All cost-basis data and taxable events will be tracked by your broker, who will issue a 1099-B with the reportable data. Generally, as securities, disposal of these ETFs would be a capital transaction subject to short-term or long-term capital-gain rates depending on the holding period.
Owning bitcoin directly requires tracking the basis and holding period, in addition to compiling the taxable transactions made throughout the year. Current holders of bitcoin may be reluctant to sell and move to an ETF due to the tax implications as well as the philosophical benefits of holding cryptographic keys, under the maxim "not your keys, not your bitcoin."
Advising advisers
Bitcoin ETFs are new, and investment advisers may not be comfortable discussing them with their clients just yet. In addition, compliance rules vary among investment advisers when it comes to their ability to offer or solicit bitcoin ETFs owing to the internal policies of their organization. For example, an investment adviser may have the ability to offer a bitcoin ETF but have restrictions around solicitation of the offering.
If you have an adviser, discuss your entire investment activity with them to make them aware of all potential gains or losses. This will help the adviser make tax-efficient decisions. For instance, gains from the sale of crypto or digital assets can be offset by losses from securities, or vice versa.
The bottom line: Bitcoin ETFs present a tremendous opportunity for investors who want exposure to the asset class and a reduced burden of ownership issues such as wallet management, key management, storage and custody and reporting for tax purposes.
Chris Brodersen is managing director of the blockchain and digital assets group at EisnerAmper, an accounting, auditing and tax firm.
More: 5 ways bitcoin ETFs are already changing how crypto is traded
Also read: Bitcoin is halving again in April. Here's why it's different this time.
-Chris Brodersen
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03-09-24 1313ET
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