I am sure that by now most people have heard the news stories and social media posts about people becoming rich overnight simply by acquiring and often forgetting about Bitcoin and other forms of cryptocurrency in recent years. Those viral stories of individuals getting lucky or unwittingly stumbling into fortunes are entertaining reads, but the reality is that cryptocurrency has become a legitimate investment opportunity attracting the attention of large institutional investors and influential CEOs such as Elon Musk, who are taking advantage of the tremendous growth of Bitcoin and other coins to enhance personal and corporate profits.
If you were one of those lucky individuals who bought into Bitcoin and other cryptocurrencies early or are a savvy investor who realized profits through the highs and lows of the market, you may be wondering how you can turn those gains into tangible assets such as real estate. Similarly, for those involved in real estate transactions, this new technology creates challenges for the parties involved who attempt to navigate a largely unregulated area of the law, while also attempting to apply current regulations to crypto transactions.
Crypto only real estate transactions
There are two primary ways in which crypto-based real estate transactions can be structured. The first is purchasing the property using unconverted cryptocurrency. At the present time, this may not be feasible in most instances since many sellers, closing agents, brokers, and other parties involved in the transaction may be reluctant to accept cryptocurrency that is not converted into U.S. Dollars. Their reluctance is well founded as the price of Bitcoin and other coins, unlike securities, fluctuates constantly, even outside of business hours. This may lead to risk intolerant sellers from accepting cryptocurrency offers and entering into contracts. If the price of a particular coin were to plummet, the buyer may not have sufficient funds to proceed with the sale.
In addition to the volatility, real estate professionals facilitating the transaction may not be willing or simply are not set up to accept cryptocurrency. Closing agents holding funds for buyers until closing are required by law to keep those funds in separate trust and escrow accounts, and must balance at the time of closing. Unlike cash or loan proceeds, cryptocurrency cannot be deposited in most U.S. Bank Accounts, and are instead held in virtual wallets managed by third-party services like Coinbase. Absent converting the coins into U.S. Dollars, a decrease in the price of the coins on the day of closing may result in a deficiency in the closing agent’s settlement account.
The real estate industry will likely need to adapt to this new technology as it becomes more prevalent by opening up escrow-like virtual wallets for the holding and exchange of the coins at closing, converting the coins into cash, or ensuring that any deficiency is satisfied prior to disbursement. Even if the closing agent has the ability to open a virtual wallet, their risk exposure remains high, as the current rules governing closing agents and attorney management of client funds, remains largely silent on cryptocurrency. Any buyer who intends on purchasing real property with crypto should ensure that the closing agent is comfortable with handling a crypto-only transaction and ensuring that should the price of the coins fall they have sufficient funds prior to entering into a contract.
Crypto Tax Treatment
Unlike with cash or financed real estate deals, there are also tax implications for purchasing and selling property with cryptocurrency. The IRS Revenue Ruling Notice, 2014-21 provides guidance on the tax treatment of virtual currency. Currently, the IRS treats virtual currency as personal property, as opposed to cash, therefore any gains realized on the sale of cryptocurrency are treated as a capital gain.
Typically, the purchase of real property does not trigger a taxable event for the buyer. With crypto, however, IRS regulations provide that the purchase of real property would result in a realization event where the buyer is taxed on the difference between the purchase price of the property, and the original basis in the coins. A buyer should seek the opinion of a tax advisor prior to purchasing property with crypto in order to understand the full potential tax liability resulting from the sale.
Crypto to U.S. Dollars
The second method of structuring the crypto real estate transaction would be to convert the cryptocurrency to U.S. Dollars — which from a real estate professionals’ perspective would be akin to handling a cash transaction. This method is likely more of a realistic possibility at the present time. Unlike with a crypto-only transaction, the risks once the coins are converted into cash, largely dissipate. However, there are still potential risks for professionals and buyers involved in these transactions, namely the above-referenced tax liability and perhaps more significantly running afoul of anti-money laundering regulations.
Anti-Money Laundering and Blockchain
Cryptocurrency utilizes blockchain technology to engage in secure and anonymous online transactions between parties. The anonymity aspect of the transactions has led to criminal enterprises conducting transactions through cryptocurrency, which effectively masks the transactions.
In a typical real estate transaction, professionals must be cognizant of possible fraud or money laundering underlying the transaction. However, in a typical transaction, the depository institutions holding the buyer’s funds act as a first line of defense through the adherence to Federal anti-money laundering regulations. With cryptocurrency, the decentralized currency is often held in wallets and exchanges, not banks, therefore real estate professionals are responsible for ascertaining the identity of buyers and ensuring that the coins within wallets were acquired legitimately.
What lies ahead?
Fortunately, there appears to be new regulations on the horizon that could potentially reduce this risk. Prior to the exit of the Trump administration, the Treasury Department began rulemaking which would require banks to ascertain identifying information for any crypto withdrawals over $10,000.00 dollars, and for transfers over $3,000.00. These regulations are similar to current anti-money laundering rules for cash and wire transfers. However, the shift from the Trump to Biden administration may cause a shift in policy related to cryptocurrency. Despite the change in administrations, increased regulation is likely on the horizon.
Real estate professions looking to get involved in these transactions may become more and more willing to entertain crypto purchases as increased regulation lowers potential exposure. While the precise framework and substance of new regulations are still up in the air, the push toward regulation may make these types of transactions more feasible going forward, and accessible for professionals who may be scared off by potential liability surrounding these types of transactions.
Overall, the shift to cryptocurrency will require additional regulation before truly becoming a mainstay within the real estate industry. While these types of transactions certainly can occur at the present time, the potential risk exposure for professionals involved in the industry will likely prevent most crypto-only transactions from occurring. In contrast, crypto to U.S. Dollar conversions likely are becoming more and more common. For buyers, sellers and real estate professionals alike, it is critical to understand the outcomes and potential risks associated when buying real property with cryptocurrency.
If you have any questions or concerns with respect to real property transactions involving cryptocurrency, please do not hesitate to give me a call. I may be reached at email@example.com or by phone at 239-344-1268.