Tax-Free Ways to Transfer Bitcoin and Other Crypto: Expert Take

Despite recent corrections in crypto markets, you might have some big gains in Bitcoin and other cryptocurrencies. But taxes are an ever-present danger, and it is clear that the Internal Revenue Service (IRS) is looking for reporting. With all the worry about so-called 1031 tax-free exchanges that can no longer be used for cryptocurrency, are there any other ways to transfer your crypto without triggering taxes? Here are some ideas, each way has pluses and minuses.

Contributing to a corporation or partnership

How about contributing your cryptocurrency to a corporation or partnership that you will control? In general, transferring property into a corporation in exchange for its stock is a taxable event.

That is, the transaction is treated as if you sold the property to the corporation in return for cash. The difference between the stock value you received, and the tax basis in the property you transferred to the corporation, will result in a gain or loss. That means taxes. Of course, you generally don’t want this sale treatment.

Fortunately, Section 351 of the tax code generally allows people to transfer property to a corporation in exchange for stock without trigger tax, even if the property is appreciated. The corporation can be either an S corporation (basically taxed as a flow-through) or a C corporation (that itself pays taxes). The corporation can be newly organized or already existing.

Of course, some requirements must be met. But if you meet them, some gains on an exchange of property for stock can be delayed. The IRS can tax it later when the shareholder eventually sells the stock received in the exchange. No gain or loss is triggered as long as you receive only stock in exchange for your property and you are in control of the corporation immediately after the exchange.

The control means the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of outstanding shares of all other classes of stock of the corporation. If you, along with others, transfer property into a corporation, you can do this as a group.  So you don’t have to have control personally.

The same kind of thing can work for partnership or LLC. Contributions of property or money in exchange for partnership interest are usually non-recognition events. In a way that is similar to the rule for corporations, the contributions can be tax-free, both to the contributing partner and to the partnership.

For partnerships, this non-recognition rule is contained in Section 721(a) of the Tax Code. It generally applies regardless of whether the contribution is made on the formation of the partnership or after it has been in existence and operating for some time. But there are some potential traps, more so with partnerships than with corporations. For example, this non-recognition rule does not apply to transactions between the partnership and a partner acting outside his capacity as a partner, or when the purported contribution is a disguised sale.

Moreover, under Section 721(b), the no tax rule also does not apply to gain realized upon a contribution of property to a partnership “investment company,” where the contribution results in the diversification of the transferor’s assets. All of these issues that can trigger taxes can be hard to spot.

How about gifts?

You can give crypto as a gift, and it doesn’t trigger income taxes. That’s right, no income tax to you as the donor, and no income tax to the recipient. Of course, when the recipient transfers or sells it, there would be income taxes then.

And at that point, the donee would need to calculate gain or loss. What is his or her tax basis, since it was a gift? The tax basis is the same as it was in your hands when you made the gift…

Read Full: Tax-Free Ways to Transfer Bitcoin and Other Crypto: Expert Take