By Jim Wilhelm
For investors who have accumulated significant cryptocurrency holdings, using those assets to purchase a home may seem like a natural next step. It is possible, but the process is not always as simple as transferring cryptocurrency to a seller.
A buyer may need to convert the cryptocurrency to cash before closing, and that conversion can create a taxable gain. Borrowing against cryptocurrency may be another option, but it carries its own financial risks. Careful planning before the transaction can help prevent unexpected tax and cash-flow issues.
Can You Purchase a Home With Cryptocurrency?
Yes. A buyer can generally use cryptocurrency to help fund a home purchase in one of two ways:
- Sell the cryptocurrency, convert the proceeds to U.S. dollars, and use the cash for the purchase.
- Transfer the cryptocurrency directly to a seller who is willing to accept it.
In practice, most traditional real estate transactions are completed in U.S. dollars. A seller may not want to accept cryptocurrency, and mortgage lenders, title companies, and closing agents may require the funds to be converted before closing.
Buyers who plan to finance any portion of the purchase should speak with their mortgage lender before converting or transferring cryptocurrency. Lenders may have specific requirements for verifying the source of the funds.
For example, current Fannie Mae guidance on virtual currency generally requires cryptocurrency to be converted to U.S. dollars and held in an eligible regulated financial institution before it can be considered an acceptable source of funds. Documentation showing ownership of the cryptocurrency and its conversion may also be required. Under this guidance, cryptocurrency cannot be used directly for an earnest money deposit.
Other lenders and loan programs may have different requirements.
Does Selling Cryptocurrency Create a Taxable Transaction?
The IRS generally treats cryptocurrency and other digital assets as property. When cryptocurrency held for personal or investment purposes is sold or exchanged, the owner generally recognizes a capital gain or loss.
The same principle applies if cryptocurrency is transferred directly to a seller in exchange for a home. Paying for the property with cryptocurrency does not eliminate the tax consequences of disposing of the cryptocurrency.
The gain or loss is generally based on the difference between:
- The taxpayer’s adjusted tax basis in the cryptocurrency
- The amount received, or the fair market value of the property received, subject to applicable transaction costs
Suppose an investor purchased cryptocurrency for $150,000 and later sold or exchanged it when it was worth $400,000. Before considering transaction costs or other adjustments, the investor could recognize an approximate capital gain of $250,000.
The purchase of the home itself generally does not create taxable income for the buyer. The potential tax liability results from the sale or exchange of the cryptocurrency used to fund the purchase.
Additional information is available in the IRS guidance on digital assets and the IRS Digital Asset Transaction Frequently Asked Questions.
Will the Gain Be Short-Term or Long-Term?
The tax rate generally depends on how long the cryptocurrency was held.
- Cryptocurrency held for one year or less generally produces a short-term capital gain or loss. Short-term gains are generally taxed at ordinary federal income tax rates.
- Cryptocurrency held for more than one year generally produces a long-term capital gain or loss. Long-term gains may qualify for lower federal tax rates.
Depending on the taxpayer’s income and filing status, the gain may also be subject to the 3.8% Net Investment Income Tax.
The holding period should be reviewed before a sale, particularly when some of the cryptocurrency is close to qualifying for long-term treatment. However, a tax benefit must be weighed against the possibility that the cryptocurrency could decline in value while the investor waits.
More information is available from the IRS regarding capital gains and losses and the Net Investment Income Tax.
Are There Ways to Reduce the Tax Impact?
There is no single strategy that works for every buyer. The right approach depends on the amount of gain, the buyer’s other income and investments, the timing of the home purchase, and the level of market risk the buyer is willing to accept.
Several planning opportunities may be worth reviewing before the cryptocurrency is sold.
Review Available Capital Losses
Capital losses from cryptocurrency, stocks, or other investments may be available to offset capital gains, subject to applicable tax rules.
An investor may also consider tax-loss harvesting, which involves selling investments that have declined in value to realize a capital loss. Any such decision should fit within the investor’s overall investment strategy. Selling an investment solely to generate a tax loss may not make sense when transaction costs, market exposure, and long-term objectives are taken into account.
Identify the Cryptocurrency Being Sold
An investor may have purchased units of the same cryptocurrency at different dates and prices. The units selected for sale can affect both the amount of the gain and whether it is short-term or long-term.
Taxpayers who want to use specific identification must meet the applicable documentation and timing requirements. If adequate identification is not made, default tax-basis rules may apply. This should be addressed with the taxpayer’s tax professional and cryptocurrency broker or custodian before the transaction occurs.
Consider the Timing of Separate Sales
If the home purchase and funding needs allow, a buyer may consider completing separate cryptocurrency sales in different tax years. This could spread the gains across two years instead of recognizing all of them in one year.
This planning must be completed in advance. A single sale that has already occurred cannot be divided between tax years after the fact.
The potential tax benefit should also be compared with the risk of continuing to hold cryptocurrency while waiting to complete a later sale.
Prepare a Tax Projection
A large gain may affect more than the taxpayer’s capital gains tax. It could also affect:
- The Net Investment Income Tax
- Income-based deductions and credits
- Medicare income-related premium adjustments
- Estimated tax requirements
- State income taxes
Preparing a tax projection before the sale can provide a clearer picture of the total cost and the amount of cash that should be reserved for taxes.
Can Cryptocurrency Be Used as Collateral for a Loan?
Some lenders and cryptocurrency platforms allow borrowers to pledge cryptocurrency as collateral for a secured loan. The borrower may then use the loan proceeds toward the home purchase without first selling the cryptocurrency.
Proceeds from a properly structured loan generally are not taxable income because the borrower has an obligation to repay them. If the cryptocurrency is only pledged as collateral and is not sold or otherwise disposed of, the loan may not create an immediate taxable gain.
That does not mean borrowing against cryptocurrency is automatically a tax-free or low-risk strategy. The terms of the loan and the lender’s treatment of the collateral must be reviewed carefully.
Potential risks include:
- A significant decline in the value of the cryptocurrency
- A margin call or demand for additional collateral
- A requirement to repay part of the loan on short notice
- Forced liquidation of the cryptocurrency
- A taxable gain or loss if the lender sells the collateral
- Interest charges, origination fees, and other borrowing costs
- Platform, custody, counterparty, and regulatory risks
- Mortgage lender restrictions on using borrowed funds for a down payment or closing costs
Because cryptocurrency values can fluctuate substantially, a loan that appears well secured when it is opened may become undercollateralized quickly. If the borrower cannot provide additional collateral or repay part of the balance, the lender may sell the cryptocurrency.
A forced sale may occur at an unfavorable time and can still create a taxable gain. Cancellation of loan debt may also create taxable income in certain circumstances.
The cryptocurrency-backed loan may need to be disclosed to the mortgage lender. Its balance and required payments could affect the buyer’s debt-to-income ratio and ability to qualify for a mortgage.
Are There State Tax Considerations?
A taxpayer who lives in a state with an individual income tax may owe state tax on the cryptocurrency gain in addition to federal tax.
State rules vary, and the result can become more complicated when a taxpayer moves during the year or maintains connections to more than one state. State tax exposure should be evaluated before a significant cryptocurrency sale or exchange.
Will an Estimated Tax Payment Be Required?
Possibly. Unlike wages, cryptocurrency sale proceeds generally do not have income tax withheld automatically. A taxpayer who recognizes a large gain may therefore need to make a federal and possibly a state estimated tax payment.
Under general federal rules, an individual may need estimated tax payments if the individual expects to owe at least $1,000 after subtracting withholding and refundable credits. Safe-harbor rules and other exceptions may apply.
The required payment depends on the taxpayer’s current-year income, prior-year tax, withholding, filing status, and the timing of the gain. A tax professional can calculate the payment and determine the appropriate due date.
The IRS provides additional information about estimated taxes and large gains.
What Records Should a Buyer Keep?
Complete records are essential when cryptocurrency is sold, exchanged, or pledged as collateral. Taxpayers should retain documentation showing:
- The date and time the cryptocurrency was acquired
- The purchase price and adjusted tax basis
- Acquisition and transaction fees
- The date and time of the sale or exchange
- The fair market value at the time of the transaction
- The number and type of cryptocurrency units involved
- The specific units selected for sale
- Exchange, broker, wallet, and bank records
- Loan agreements and collateral statements, if applicable
- Transfers of funds into the buyer’s bank or closing account
Tax forms provided by a cryptocurrency broker may not contain every piece of information needed to calculate the correct gain or loss. The taxpayer remains responsible for maintaining complete and accurate records.
Frequently Asked Questions
Can I avoid tax by transferring cryptocurrency directly to the seller?
Generally, no. Exchanging cryptocurrency for real estate is ordinarily treated as a disposition of the cryptocurrency. The owner may have to report a gain or loss based on the cryptocurrency’s adjusted basis and the amount realized in the exchange.
Is buying the home itself taxable to the buyer?
The purchase of a home generally does not create federal taxable income for the buyer. The taxable event usually results from selling or exchanging the cryptocurrency used to fund the purchase.
Will every mortgage lender accept funds from cryptocurrency?
No. Lenders may have different requirements for documenting, converting, transferring, and holding the funds. A buyer should discuss the planned transaction with the lender before moving any cryptocurrency.
Is borrowing against cryptocurrency better than selling it?
Not necessarily. Borrowing may avoid an immediate sale in some circumstances, but it also introduces debt, interest expense, collateral requirements, and the risk of forced liquidation. The tax and financial consequences of both options should be compared.
Should cryptocurrency be sold before making an offer on a home?
That depends on the buyer’s tax situation, market exposure, available cash, expected closing date, and the lender’s requirements. Ideally, the buyer should coordinate with tax, financial, mortgage, and real estate professionals before taking action.
Planning Before the Purchase
Using cryptocurrency to purchase a home is possible, but the tax consequences and practical requirements should be considered before the transaction begins.
A buyer should understand:
- The tax basis and holding period of the cryptocurrency
- The expected federal and state tax liability
- Whether estimated tax payments will be needed
- How the sale may affect the buyer’s broader investment strategy
- The lender’s documentation and source-of-funds requirements
- The risks and costs of a cryptocurrency-backed loan
- The records needed to support the transaction
With advance planning, buyers can make a more informed decision about how much cryptocurrency to sell, when to sell it, and whether borrowing against it is appropriate.
Campbell & Company can help clients evaluate the tax consequences of a proposed cryptocurrency transaction and coordinate the planning with their financial, legal, mortgage, and real estate professionals. Learn more about our tax preparation and planning services or contact Campbell & Company before completing a significant transaction.
This article is provided for general informational purposes only and should not be considered tax, legal, investment, mortgage, or lending advice. Tax laws, cryptocurrency regulations, and lending requirements may change. Readers should consult qualified professionals regarding their individual circumstances.
