On January 10, 2024, the SEC approved the listing and trading of more than 10 different spot bitcoin exchange-traded funds (ETFs). Investors in these new products may wonder what their tax implications are. Let’s dive in:
What the SEC Approved
- Bitcoin spot ETFs: A bitcoin ETF operates like a Gold ETF where the ETF issuer purchases the underlying asset and stores it on the investor’s behalf as a custodian. These products are actively traded during standard trading windows. Essentially, investors are paying a management fee to the ETF issuer in exchange for the administrative burden of the purchasing, storing, and safekeeping of the assets.
- How this could impact investors: Retail investors will now be able to gain access to bitcoin through more traditional financial institutions. BlackRock, Fidelity, ARK Invest, and others are now offering these funds.1 Investors could purchase this ETF through a normal brokerage account, IRA, and potentially other retirement accounts.
Tax Implications
- Structure and custody: Bitcoin ETFs are structured like other spot commodity ETFs, e.g., a Gold ETF, that own a single asset.2 Grantor trusts are generally considered as a disregarded entity for tax purposes. This differs from stock and bond ETFs, which are typically structured as regulated investment companies.
- Taxable events: With the spot ETFs formed as grantor trusts, this would typically generate a taxable event for the investor if they were to sell their investment. Reg. Section 1.671-5 provides guidance to treat the sale of assets within the grantor trust as being a taxable event only for the taxpayer redeeming the units. That said, it is possible that taxpayers who hold shares in these funds could have a taxable event even in a year they have not sold their shares.
Tax Reporting
- 1099s: Taxpayers who purchase shares in the funds through a typical brokerage account may have the taxable events summarized in a Form 1099-B. Even if the information is not reported and summarized on a Form 1099-B, the taxpayer is still required to report any taxable event on their annual income tax return. In addition, even if the information is reported on a Form 1099-B, taxpayers may have to use tax information reports to adjust the basis reported on their 1099-B.
- Tax information reports: Grantor trusts do not typically issue Forms 1099 to investors. Instead, they may issue a tax information report. These tax information reports are provided so taxpayers can determine their share of gain or loss resulting from the fund selling assets to cover management fees.
Thus, it is possible that taxpayers who invested in one of these spot bitcoin ETFs could have a taxable event to report in a year in which all they did was buy and hold shares in the fund.
Tax Planning
- Wash sales: As the Internal Revenue Code (IRC) is currently written, wash sale rules (IRC 1091) do not apply to direct crypto asset investment. Wash sale rules generally do not apply to direct crypto asset investment because they are not considered stock or securities in the lens of the IRS. However, because these new spot bitcoin ETFs are registered securities with the SEC, the wash sale rule could apply to these specific investments.
- Wash sale rules generally prevent taxpayers from recognizing a loss on their income tax return after selling an investment at a loss and then repurchasing the same or substantially identical investment within a 30-day period.
- Management fees: Passed in 2017, the Tax Cuts and Jobs Act disallows fund expenses as a miscellaneous itemized deduction. These deductions are phased out until tax year 2026, in which they will become deductible again unless additional legislation is passed to extend the disallowance.
Why It Matters
Investing in a spot bitcoin ETF could create complex tax situations, as well as add to the overall administrative burden of tax reporting. Having the right team behind you can help ease your mind. FORVIS is ready to help. If you have any questions or need assistance, please reach out to a professional at FORVIS.