For the US-based investor, tax-efficient investing is a top priority when choosing how to effectively deploy capital. While at Goldman, I worked with entire groups focused on tax-efficient investing. It came in the form of municipal bond desks focused on building portfolios of tax-free income generating bonds for ultra-high net worth clients of the firm, or asset management groups that create diversified equity portfolios that target zero capital gains distributions. The point is, outside of it being our patriotic duty to pay taxes to fund government spending, no smart investor wants to pay more taxes than he/she needs to.
Stepping into the digital asset space, the tax picture becomes muddled; do I use FIFO or LIFO, do I need to identify the exact coins sold, etc. LedgerX had its fair share of questions for Treasury. Most importantly, how is a physically settled options contract on Bitcoin taxed? We worked tirelessly with our contacts at Treasury to get any clarity and the best we could get was physically settled options on digital assets will likely be treated similarly to single stock equities or commodities. Treasury specifically highlighted the contracts will not be treated like traditional currency options. Now the ‘clarity’ Treasury provided was helpful, but unfortunately no one is knocking on LedgerX’s door to trade these options because they are a tax efficient investment.
Now we get to the exciting news. In late 2019, LedgerX is seeking regulatory approval for a third license from the CFTC, a Designated Contract Market (DCM). This will allow us to rebrand our existing contracts from swaps and options, to futures and options on futures. This is especially important because the IRS has deemed both futures and options on futures as 1256 Contracts. This tax designation was created with physical commodity hedging in mind as a way to not penalize users for managing risk. The main feature of 1256 Contracts is any gain or loss is treated for tax purposes as 60% long-term gain and 40% short-term. This mixture produces a blended 23% tax rate when using current tax levels, a huge savings compared to the tax treatment for spot trading.
When rolled out, the LedgerX spot look-a-like contract will be the most tax efficient way to get long physical BTC exposure. Currently, if you want to buy 500 BTC, LedgerX is 25bps + $3 (trading fee) away from mid which all in is about 30-35bps ($12-15 away from mid). Most of the large OTC shops are closer to 50-100 bps for that size while the US regulated exchanges are 75-100bps when you factor in fees. Now if you are a very large institution and make friends with the OTC players, maybe you can get better spreads from them. However for the average investor, when factoring in fees and taxes paid, LedgerX offers the best solution for investing in BTC.
**I’ve been scolded enough times in my life by compliance officers to end any blog on taxes without the appropriate disclosures. On that note: ____________ (insert name of any investment bank, broker dealer, or crypto startup you choose) and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.