Many California residents wish to avoid paying US capital gains tax and California income tax on their crypto assets, but don’t wish to give up their US citizenship and pay an expatriation tax (to learn more about expatriation tax planning, click here). With Congress and the IRS now taking steps to ensure that tax is being paid on the sale of virtual currency (which the US treats as the sale of property for tax purposes), many crypto investors are looking for a solution. Moving to Puerto Rico is an alternative that could slash capital gains tax rates on crypto assets to between zero and 5%, while retaining your US citizenship and avoiding acceleration of tax on your virtual currency gains on the way out of California.
First, to cut off California’s right to tax the subsequent sale of the cryptocurrency, your move must be planned and executed to effectively terminate your California tax residence and domicile prior to the sale. For a discussion of when a domicile change becomes effective for California tax purposes and why you should wait to sell appreciated assets until you are sure your domicile change is effective, click here.
Second, post-move income and gains earned outside the U.S. may be permanently exempt from U.S. tax if certain requirements are met. Importantly, the crypto investor must take steps to qualify as a “bona fide resident” of Puerto Rico (“PR”) after the move. To so qualify, three tests must be satisfied: (i) a “presence” test (referring to time spent in PR each year); (ii) a “tax home” test (requiring that your principal place of business (or if you gave none, your principal residence) be located in PR; and (iii) a “closer connection” test (which requires that you develop and retain a closer personal connection to PR than to the US for the tax years in question). Each of these tests have detailed rules that must be satisfied.
Income qualifies as exempt “Puerto Rico source income” for U.S. tax purposes if it is determined to have its source in Puerto Rico or to be income effectively connected (“ECI”) with a business operated in Puerto Rico. U.S. tax rules for sourcing income and identifying ECI are applied for this purpose by substituting “Puerto Rico” for the “United States” in their application. Thus, because under those U.S. rules, the source of capital gains from the sale of personal property is determined based on the residency of the seller, capital gains realized on the sale of virtual currency following a tax effective move to Puerto Rico should have their source in Puerto Rico, from a U.S. tax point of view.
Finally, to qualify for the Puerto Rican tax incentives discussed below, you must apply for and obtain a grant under the Puerto Rico Incentives Act No. 60 (2019), purchase a home in Puerto Rico within two years of your arrival and contribute a minimum of US$10,000/year to specified Puerto Rican charities. If you satisfy these requirements, you may benefit from significant tax exemptions and tax rate reductions, including on interest, dividends and capital gains.
The rate of capital gains tax depends on when the appreciation in the property sold accrued. The portion of any net long-term capital gain attributable to appreciation occurring prior to the date PR residency begins is subject to a 5% Puerto Rico tax, if the gain is recognized at least ten years after the owner becomes a resident of Puerto Rico.
However, post-move appreciation (i.e., that occurring after you no longer have a “tax home” outside Puerto Rico) will be completely exempt from PR income taxes. Some investors will wish to start earning qualifying exempt capital gains as of the date they begin PR residence by selling, realizing and using crypto currency (e.g., Bitcoin) losses to offset gains prior to departure. Since the “wash-sale” rules do not presently apply to sale of crypto-currency, a repurchase of the same or other virtual currency after realizing your existing losses should not prevent use of the losses prior to departure.
If you would like help in evaluating your options (including concerning other special tax incentives in Puerto Rico for operating a global service business) and with qualification for tax exemptions, please contact us for a consultation.
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Lance Cross-Border Law and Tax is the premier cross-border tax law firm in California advising clients concerning California, federal and International tax issues. Learn more about our complete range of cross-border tax planning services at: www.lancecrossborder.com.
The information in this blog post is provided for general informational purposes only. It does not and is not intended to constitute legal advice from the author on any subject matter. Nor is it intended as a substitute for legal research or a consultation on specific matters. Always seek appropriate legal advice concerning your particular facts and circumstances before proceeding with your plans.
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