ContextIn the US, President Biden is proposing to roughly double the
top marginal long-term capital gains tax rate. The exact details have not been published, but at this point the rumors I'm hearing make it sound as though it would work like this: If you have capital gains (long-term plus short-term) higher than $1 million in a year, then each dollar
over $1 million would be taxed at 43.4%. This is more similar to the Net Investment Income Tax rather than creating a new CG tax bracket; normally, your ordinary income basically shifts down the capital gains tax brackets for you so that more ordinary income causes you to pay higher CG tax rates, but from what I'm hearing, this will not be the case with this extra tax. The top marginal short-term capital gains tax rate would also increase from 40.8% to 43.4% on income above about $400k.
What actually gets passed into law may be different from what Biden proposed. All Republicans will vote against any tax increase, so each and every Democrat would have to agree to any tax increase. I watch politics very closely, and here's how I'd rate the chances:
- 30% probability: There is no LT capital gains tax increase at all. In the Senate, every Democrat up for reelection would prefer not to vote to increase taxes, since it will be used against them. Moderates like Manchin will be opposed to it because it hurts their moderate image. Even many deep-blue Democrats may be opposed to it in private because they represent places like Silicon Valley; I'd guess that the majority of unrealized capital gains are in deep blue states.
- 20% probability: Biden's proposal goes through basically intact. You may be surpised that I consider this so likely, since the moderate Democrats have a reputation for blocking big stuff like this, but the fact is that increasing taxes on people making more than $1 million is extremely popular, especially among the Democratic base, and if Biden and his allies choose to push hard on this particular issue, I'm pretty sure that they can get all Democrats, even Manchin, onboard. The question is whether Biden cares about this enough to grant the moderates a lot of concessions and spend a lot of political capital in order to force this through.
- 50% probability: Biden's proposal goes through, but with the rate reduced from 43.4% to 28-30%. This will help to appease the Democratic senators who would otherwise be opposed to it.
In any case, I expect the change to apply to sales made in 2022, not retroactively to sales made in 2021.
Spacing out gainsThe proposed increase is only on capital gains above $1 million. If you have less than $1 million in unrealized gains, then maybe someday it will affect you, but probably no action is required now. If you have a few million dollars in unrealized gains, then you should consider whether you could spread these gains out over a few years to stay below the $1 million limit.
Spreading gains out is harder than it sounds. If you have $10 million in unrealized gains which you plan to spread out over 10 years to stay below the limit, you may run into problems like:
- Unexpected expenses may occur, such as unexpected medical bills. Or unanticipated expenses may be desired, such as deciding to move.
- The BTC price may go up, so now you're sitting on $100 million in unrealized gains. (A good problem to have in many ways, but a risk to consider.)
- The BTC price may go down, and this may cause you to lose faith in BTC and want to sell. If your $10 million in unrealized gains shrinks to $5 million because the BTC price got cut in half, are you going to be tempted to sell more, even at a higher tax rate? Relatedly, you might decide that other investments look more attractive than BTC, especially if you have a huge portion of your net worth in BTC. You won't be able to buy stocks with your BTC without realizing the capital gains, for example. Maybe now you don't think that this will ever be an issue, but trying to anticipate your mindset years in the future is very difficult.
- Tax laws may change. There was just a tax cut in 2017, for example.
Note that some services will give you a low-interest loan using your BTC (or other property) as collateral, similar to a home equity line of credit. This is a strategy commonly used by people like Jeff Bezos or Elon Musk who have most of their wealth in unrealized capital gains to avoid realizing the gains all at once. It's not a free lunch, though: you'll still be paying interest and fees.
You don't have to just sell all of your BTC and be rid of it forever. You can sell it to realize the gains, set aside the appropriate amount for taxes, and then immediately use the remaining dollars to buy back BTC. This is called tax gain harvesting, and it is a common tax strategy.
The value of waitingFor ease of calculation, in this section I will assume that the capital gains tax rate is increasing from 23.8% to 43.4% on all capital gains, not merely on amounts above $1 million, and ignoring tax brackets. Also, when I say that you are "realizing gains", I mean that you are doing tax gain harvesting: selling BTC and then immediately using the cash minus taxes to buy back BTC.
Let's say that you have some BTC with zero cost basis, now worth $1 million. So $1 million in unrealized capital gains. If you realize it now, you'll have $762,000 leftover. If you realize it this time next year and the BTC price is the same, you'll have only $566,000 leftover. Not great: you should've realized it this year.
However: If you realize your gains now and the BTC price quadruples, you'll have $3,048,000. Realize the remaining gains on that and you're left with $2,055,876. If the BTC price quadruples, and
then you realize the gains, you'll have $2,264,000. It was better to wait to realize the gains in this example, though here we're assuming a pretty incredible quadrupling of the BTC price in 1 year.
If the BTC price ends up rising faster than the rate of inflation on average, then it may be worthwhile to wait to realize your gains. However, especially if the tax increase is as significant as Biden proposes, you might have to hold onto your BTC for
decades in order to break even, depending on how much/quickly BTC rises. And if BTC rises slower than the rate of inflation, then all else being equal, it'd be better to realize your gains sooner. Nobody can predict with much accuracy where you, your mindset, Bitcoin, the tax system, the dollar, etc. will be in 10 years, so I caution against cavalierly making plans stretching decades into the future...
In the previous example where the BTC price quadruples, I'll say that the "holistic tax rate" is
1-(2055876/4000000) = 48.6% for the strategy of realizing gains now, and
1-(2264000/4000000) = 43.4% for the strategy of waiting until the BTC price rises 400%. This holistic tax rate takes into account both the actual taxes paid and the gains lost-out-on by selling sooner rather than later. Note that the holistic rate for the waiting strategy is the same as the 43.4% nominal tax rate.
I calculated the "realize now strategy" holistic tax rates for certain potential future tax rates and
after-inflation BTC price increases:
After-inflation BTC price rise
New tax| 100% 110% 150% 200% 400% 800% 1600% 2000% 4000%
|--------------------------------------------------------------------------------------
23.80% | 23.800% 25.449% 29.845% 32.868% 37.402% 39.669% 40.802% 41.029% 41.482%
25.00% | 23.800% 25.532% 30.150% 33.325% 38.088% 40.469% 41.659% 41.898% 42.374%
28.00% | 23.800% 25.740% 30.912% 34.468% 39.802% 42.469% 43.803% 44.069% 44.603%
30.00% | 23.800% 25.878% 31.420% 35.230% 40.945% 43.803% 45.231% 45.517% 46.089%
35.00% | 23.800% 26.225% 32.690% 37.135% 43.803% 47.136% 48.803% 49.137% 49.803%
40.00% | 23.800% 26.571% 33.960% 39.040% 46.660% 50.470% 52.375% 52.756% 53.518%
43.40% | 23.800% 26.806% 34.824% 40.335% 48.603% 52.737% 54.804% 55.217% 56.044%
H=1-(0.762-T*0.762+(T*0.762)/G)
Ignoring tax brackets/limits and ignoring/assuming many things about the future, your circumstances, etc.: It'd make more sense to realize gains now rather than wait if the holistic tax rate in the table above is lower than the nominal tax rate on the left. For example, it'd be better to realize gains now if you think that the tax rate will rise to 43.4% and you think that BTC will increase by 150% by the time you want to sell, because 34.8% is less than 43.4%. But it'd be better to wait if you think that the tax rate will rise to 30% and you think that BTC will increase by 400% by the time you want to sell, because 40.9% is greater than 30%.
Use the table/formula above only as a very rough guide. I totally ignored brackets, limits, cost bases, etc. in the above calculations, but these are very significant and should definitely be accounted for. You should do your own calculations taking these into account, as well as your personal circumstances. You may have state capital gains taxes, for example, and some states are even considering increasing these on top of the possible federal increase.
Also, importantly, the BTC price increases above are
after inflation. If BTC increases to $1 million in 10 years, then that's a 2000% increase from $50k
pre-inflation, but a 1562% increase after inflation if inflation averages 2.5%/yr over those 10 years.
I am not a tax professional or financial planner. This is not tax or legal advice.
