Transferring bitcoin and other cryptocurrencies tax-free

After stratospheric gains, there have been some recent corrections in bitcoin and other crypto markets. Even so, you might have some big gains you'd like to realize. Of course, taxes are an ever-present danger, and it is clear that the IRS is on the hunt. The IRS is pursing tax enforcement with summonses, tracking software and training its criminal IRS agents.

So-called 1031 tax-free exchanges can no longer be used for crypto. However, are there any other ways to transfer your crypto without triggering taxes? There are, but each has plusses and minuses. Here are some ideas.

How about contributing your crypto to a corporation or partnership that you will control? Let's take corporations first. 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, so 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, there are requirements that 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 stock received in the exchange is eventually sold by the shareholder. Under section 351(a) no gain or loss is triggered as long as: (1) you receive only stock in exchange for your property; and (2) you are in control of the corporation immediately after the exchange.

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 personally have control.

How about a Partnership or LLC? The same kind of thing can work for contributions of property to partnerships in exchange for partnership interests. Contributions of property or money to a partnership are usually non-recognition events, if the contributions are in exchange for a partnership interest. 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 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 actually 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. So if you are making transfers of crypto to a partnership or LLC, you may want to get some professional advice.

How about gifts? You can give crypto as a gift, and it doesn't trigger income taxes. There is 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.

Keep in mind that to avoid income taxes, a gift has to really be a gift. With gifts not being subject to income taxes, it can seems tempting to try to characterize money or property you receive as gifts. But be careful: the IRS hears this 'it was a gift' excuse a lot. The tax law is littered with cases of people who claimed something was a gift, but who got stuck with income taxes.

The IRS is unlikely to be persuaded unless you can document it. Plus, the IRS will expect a gift to occur in a normal gift-like setting. For example, if an employer or former employer gives a loyal employee $10,000, is that a gift? No, it is a bonus, treated as wages. Even trying to document it as a gift may not change that result.

True gifts may not trigger any income taxes, but there could be gift taxes involved. If you give crypto to a friend or family member -- to anyone really -- ask how much it is worth. If the gift is worth more than $15,000, it requires you to file a gift tax return. For 2018, $15,000 is the amount of so-called "annual exclusion." You can give gifts up to this amount each year to any number of people with no reporting required.

Any gifts over that $15,000 amount require a gift tax return, even though you may not have to pay any gift tax. Rather than paying gift tax, you normally would use up a small portion of your lifetime exclusion from gift and estate tax. For 2018, that number went up dramatically. The amount you can transfer tax-free during your life or on death just went up to $11.2 million per person. That is $22.4 million per married couple.

What if your gift isn't to a person, but to charity? If you give to charity, that can be very tax-smart. If you give crypto to a qualified charity, you should normally get an income tax deduction for the full fair market value of the crypto. If you bought it for $500, and donate to a 501(c)(3) charity when it is worth $15,000, you should get a $15,000 charitable contribution deduction. What's more, you won't have to pay the capital gain or income tax on the $14,500 spread. That's a good deal. It is why tax savvy people like Warren Buffett generally donate appreciated property rather than money to charity.

Finally, remember, if you use crypto to buy something, the IRS considers that a sale of your crypto. You have to calculate gain or loss. You might have bought something with your crypto. But you made a sale in the process!