How do U.S. individual investors pay taxes on Bitcoin ETF investments?
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How do U.S. individual investors pay taxes on Bitcoin ETF investments?
As the cryptocurrency industry celebrates the long-awaited approval of a spot Bitcoin exchange-traded fund (ETF), investors must understand how the IRS will tax these products.
Navigating Web3 tides with focused insightsTranslation: TaxDAO
As the cryptocurrency industry celebrates the long-awaited approval of spot Bitcoin exchange-traded funds (ETFs), investors must understand how the Internal Revenue Service (IRS) will tax these products.
What Is a Bitcoin ETF?
An ETF is a financial instrument that allows investors to gain exposure to various assets and sectors through a single share. A Bitcoin ETF enables investors to invest in Bitcoin without directly holding the cryptocurrency.
The launch of an ETF involves multiple participants. In a Bitcoin ETF, authorized participants (APs)—typically market makers or large banks—provide cash to a grantor trust established by sponsors such as Ark Invest or BlackRock. The trust then uses this cash to purchase Bitcoin and issues shares representing the underlying Bitcoin holdings back to the APs. These ETF shares are subsequently sold on public exchanges like the New York Stock Exchange or Nasdaq to retail investors. ETF sponsors typically charge an annual fee (expense ratio) to cover operational and management costs. As of December 31, 2022, the industry’s average expense ratio was 0.47%. Last but not least, regulatory oversight comes from the Securities and Exchange Commission (SEC), which must first approve the sponsor’s application before the ETF can begin trading.
Futures-based Bitcoin (or any other cryptocurrency) ETFs track Bitcoin prices through futures contracts. Since October 2021, several futures-based Bitcoin ETFs have been approved for trading, including ProShares Bitcoin Strategy ETF (BITO), ProShares Short Bitcoin ETF (BITI), VanEck Bitcoin Strategy ETF (XBTF), among others. As the market leader, BITO manages $2 billion in assets.
How Are Bitcoin ETFs Taxed?
Taxation of ETFs starts with capital gains assessment—but it doesn’t end there.
If you sell your Bitcoin ETF holdings within one year of acquisition, the resulting short-term capital gains are subject to ordinary income tax rates, which could range from 10% to 37%, depending on your total taxable income and filing status.
If you hold the ETF for more than 12 months before selling, the resulting long-term capital gains are taxed at preferential capital gains rates—either 0%, 15%, or 20%, depending on your overall taxable income and filing status.
Additionally, if your income exceeds the thresholds below, you may also be subject to an extra 3.8% tax on top of the capital gains taxes mentioned above.
But this isn't the only way capital gains taxes are assessed. Bitcoin ETFs spend a small portion of their Bitcoin holdings throughout the year to pay management fees. These transactions generate capital gains or losses due to the difference between the cost basis of the Bitcoin sold and its market value at the time of sale. For example, if a fund sells Bitcoin at a $40,000 profit to cover management expenses, those gains are passed through and taxed proportionally to each investor based on their ownership stake in the fund.
Prior to the passage of the 2018 Tax Cuts and Jobs Act, investors could deduct their pro-rata share of fund expenses as miscellaneous itemized deductions on Schedule A. Unfortunately, due to restrictions introduced by that law, such deductions are no longer allowed and won’t become available again until after December 31, 2025.
Compared to spot ETFs, futures-based Bitcoin ETFs (like BITO) may have slightly different tax implications for holders. The specifics depend on the structure of these funds, particularly whether they are exposed to regulated or non-regulated futures contracts (as defined under IRC §1256). If a fund holds regulated futures contracts—typically traded on dominant Bitcoin futures platforms like the Chicago Mercantile Exchange (CME)—then under IRC §1256, regardless of holding period, 60% of gains are treated as long-term capital gains and 40% as short-term capital gains.
If the fund is exposed to non-regulated contracts, gains follow normal capital gains rules similar to stocks. Note that taxation of futures contracts can be highly complex, depending on the facts and circumstances of the contracts and certain tax elections made by the fund or the investor. These factors can significantly affect when and how much tax a taxpayer owes.
Moreover, if you trade crypto futures ETFs, fund expenses are usually paid in cash, which does not trigger the same kind of capital gains or cost basis adjustments seen with spot ETFs.
Key Tax Considerations for Bitcoin ETF Investors
ETF holders may receive two types of tax compliance documents at year-end—Form 1099-B and Trust Tax Information Statements—to fulfill their tax obligations.
Brokers may issue Form 1099-B to report gains and losses from the disposition of ETF units. This form reports the cost basis of the ETF units, the sale price, and the resulting gain or loss. (Under proposed broker reporting regulations, starting with the 2025 tax year, this information may instead appear on a new dedicated digital asset transaction form, Form 1099-DA.)
Meanwhile, the Trust Tax Information Statement will show the amount of Bitcoin used during the year to pay management fees. Using Bitcoin to pay fund expenses may result in capital gains (or losses). This document explains how to calculate your proportional share of the capital gains or losses generated from these transactions. You must manually compute this information using the Trust Tax Information Statement, as it will not appear on Form 1099-B. These statements are unique to ETFs structured as grantor trusts. Most investors may be unfamiliar with them.
Finally, in the year you sell your ETF shares, you’ll need to adjust the cost basis reported on Form 1099-B by incorporating data from the Trust Tax Information Statement to arrive at the correct gain or loss. This process can make tax compliance cumbersome for ordinary taxpayers. This is why it remains important to closely monitor developments surrounding future approvals of spot BTC ETFs.
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