Many California residents wish to avoid paying US capital gains tax and California income tax on their crypto assets, but don’t wish to give up their US citizenship and pay an expatriation tax (to learn more about expatriation tax planning, click here). With Congress and the IRS now taking steps to ensure that tax is being paid on the sale of virtual currency (which the US treats as the sale of property for tax purposes), many crypto investors are looking for a solution. Moving to Puerto Rico is an alternative that could slash capital gains tax rates on crypto assets to between zero and 5%, while retaining your US citizenship and avoiding acceleration of tax on your virtual currency gains on the way out of California.
First, to cut off California’s right to tax the subsequent sale of the cryptocurrency, your move must be planned and executed to effectively terminate your California tax residence and domicile prior to the sale. For a discussion of when a domicile change becomes effective for California tax purposes and why you should wait to sell appreciated assets until you are sure your domicile change is effective, click here.
Second, post-move income and gains earned outside the U.S. may be permanently exempt from U.S. tax if certain requirements are met. Importantly, the crypto investor must take steps to qualify as a “bona fide resident” of Puerto Rico (“PR”) after the move. To so qualify, three tests must be satisfied: (i) a “presence” test (referring to time spent in PR each year); (ii) a “tax home” test (requiring that your principal place of business (or if you gave none, your principal residence) be located in PR; and (iii) a “closer connection” test (which requires that you develop and retain a closer personal connection to PR than to the US for the tax years in question). Each of these tests have detailed rules that must be satisfied.