Six tax planning strategies for low-cost-basis cryptocurrency: Pursue these strategies as part of a multiyear plan to help a client avoid a big tax hit when it comes time to cash in significantly appreciated crytocurrencies.

• Author: Sarenski, Theodore J.

Imagine that a client or a prospective client reaches out, seeking advice on the most tax-efficient way to divest virtual currency that has appreciated significantly since it was purchased some years ago. Knowing that virtual currency is treated as property for tax purposes, what strategies come to mind that would help the client achieve her objective? Following are six strategies that advisers might consider when working with clients who have appreciated virtual currency (aka cryptocurrency or cryptoassets).

Tax bracket management

This thought might come to mind first: Specifically identify high-basis units of the cryptoasset and sell them to take advantage of preferential tax rates on assets that are held for more than one year. The client could sell just enough cryptocurrency so that she does not trigger any capital gains taxes or get pushed into a higher tax bracket. For example, in 2020, if she is filing as a single individual, she could sell cryptoassets with enough inherent capital gains that, when added to any other income, and minus applicable deductions, her total taxable income does not exceed $40,000 ($80,000, if she is married and filing jointly), and she would pay no federal income tax on the capital gains. Like many of the other strategies covered in this column, depending on the dollar value of the cryptocurrency holdings, divesting the entire asset holdings might require multiyear planning.

Establish citizenship or residency in a tax-friendly jurisdiction

If avoiding taxes entirely is of great importance to the client, she could establish residency in a more tax-friendly jurisdiction (e.g., the Bahamas) and renounce her U.S. citizenship. If renouncing her U.S. citizenship is a bit too extreme, she could at least establish residency in a U.S. state that has no income tax.

Borrowing or lending crypto

There is a rapidly growing ecosystem in the crypto space called decentralized finance, or DeFi, which is the market for lending and borrowing cryptoassets. Lenders will seek the highest yield possible on their cryptoassets (this is called yield farming). Interest earned while lending the cryptoasset will, of course, be taxed at ordinary income rates, so unless the asset is held in a tax-deferred account such as a self-directed individual retirement arrangement (IRA), this strategy might be suboptimal from a tax perspective.

Borrowing against a cryptoasset allows the client to diversify into a different type of cryptoasset (please...