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Bitcoins and 1031 exchanges

The value of Bitcoin has soared over the last month, meaning that numerous Maryland residents who benefited from the soaring prices will face large tax bills if they cash in on their profits. This begs the question: Is there a way to bypass capital gains on these transactions?

Tax preparers have asked the same question, and some have wondered if it will be possible to lower the tax burdens related to Bitcoin through what's called a 1031 exchange. However, if the new tax bill passes, it could render the 1031 exchange ineffective as a tax planning strategy.

What's a 1031 exchange?

A 1031 exchange involves treating Bitcoin as property rather than currency. In the case of a 1031 exchange, taxpayers exchange one kind of asset for another, similar kind of asset. This allows the investor to postpone capital gains taxes on the investment. There are some other qualifications for a 1031 exchange but that's the general idea. It can be advantageous from a tax planning perspective to do a 1031 exchange in many situations because when the second asset is sold it can result in less of a tax burden.

A lot of investors have been thinking that, since the IRS was viewing Bitcoin as property, they could treat it as a 1031 exchange on their tax forms. Meanwhile, tax advisors have been looking to the IRS for guidance. The new tax bill making its way through the U.S. legislature would clarify the question by limiting 1031 exchanges to only real estate transactions.

Planning for Bitcoin-related taxes

Considering that Bitcoin has risen from $997 to over $18,000 this year so far, tax planning for Bitcoin purchases will be a very important point for many investors who owned the cryptocurrency this year. Ultimately, the more you understand about capital gains taxes and how they apply to investing, the better equipped you'll be to navigate this issue.

If you're not sure where you and your Bitcoin transactions stand in terms of your 2017 taxes, be sure to learn as much as you can about taxes as they apply to investors.

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