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April 4, 2022

What Crypto Traders Need to Know About Taxes

with

Patrick Larsen of ZenLedger, a leading crypto tax solution

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Tune in to my discussion with Patrick Larsen, the CEO of ZenLedger, where we talk shop about crypto taxes. Trust me, you're going to want to listen to this episode.

Why? Because filing taxes can be a byzantine, stressful experience,  and in the past crypto investments have almost always complicated this process. However, as the crypto industry has matured and more information and tools are made available, it’s getting much easier to file your crypto taxes without wanting to tear your hair out. At the end of the day, serious crypto investors, founders, and builders want to remain legally compliant, not skimp on taxes and remain off the grid – and Patrick has unique insights on how to do this as efficiently and painlessly as possible. 

Patrick Larsen is the co-founder and CEO of ZenLedger, a leading crypto tax solutions provider. Prior to ZenLedger, Larsen was an Amazon business manager responsible for a $100M+ P&L and an M&A investment banker focused on marketing analytics and e-commerce startups. Prior to the above successes, Larsen served in the US Air Force and is a former Navy helicopter mission commander.

Mark Lurie:

Welcome to WTF Crypto, where we explore the crypto universe to understand what's really going on and how it affects you and your portfolio. I'm your host, Mark Lurie of Shipyard Software. And as a caveat, nothing in this podcast is legal, investing, or in this case, tax advice. Today, we're talking about taxes in crypto with Patrick Larsen of ZenLedger, a leading provider of crypto tax software. Welcome, Pat. Thanks so much for joining us.


Patrick Larsen:

Yeah. It's a pleasure. Thanks, Mark.


Mark Lurie:

So we've all heard of John McAfee, a leading proponent of cryptocurrency and founder of the famous antivirus software of his name. And many of us also may know he recently died while in jail in Spain. What you may not know is that he was in jail awaiting extradition to the United States for tax evasion. And the lesson there is that, I think that taxes matter, not just for moral reasons, but because the government may send people with guns to come knocking at your door or put you in jail in Spain. Tax is so relevant, but also because of financial reasons. So it's relevant to our listeners, not only as they trade, because it may inform their trades, but also because tax policy affects so much of the world around us and what happens in cryptocurrency and why the markets behave the way they do. I'm super excited to talk about all of that with you today. Why don't you start by giving us a little bit of context for what makes you such a credible expert and guide on this subject?


Patrick Larsen:

I appreciate, that's very kind of you, a lot of implicit assumptions there. Yeah. So quick background is, I founded ZenLedger in 2017 and we started as a TurboTax for cryptocurrency company, but we have since turned into more of a massive ingestion engine of crypto transactions, because that's what you have to do to get the taxes, you have to bring in every transaction from day one through every centralized exchange and every on chain transaction, every wallet, every DeFi, every Dow, DEX, NFT, so that everything matches up and we can produce your taxes and audit report and audit defense, tax loss harvesting, cash optimization, overseas reports for FinCEN 114, FBAR. All of that comes out of being able to bring all the transactions together and clean them up.


Mark Lurie:

Okay. Awesome. And just so everyone has context, you have quite an interesting background as well. Before you were even in technology, you were in the US military and you were a pilot, right?


Patrick Larsen:

Yep, that's correct. So I grew up in Southern California, half Vietnamese, mom's side of the family fought with the French and then with the Americans. So they had to flee in 1975. So I grew up in Little Saigon in Southern California and then went to the Air Force Academy for undergrad, studied chemistry, and then commissioned in the US Navy and became a helicopter pilot and did search and rescue and medical evacuation with two combat tours and then got out of the Navy and got my MBA at University of Chicago, mostly finance and accounting, but a bunch of the entrepreneurship track and case studies as well. Spent a year in M&A I banking and then have been in tech, in fintech for about 10 years, ran a retail business unit at Amazon and co-founders ZenLedger in 2017.


Mark Lurie:

Okay, great. So you have a wide variety of experiences and a lot other perspective to bring. I just want to pause and say two things. One, thank you for your service, especially in search and rescue, such an important thing.


Patrick Larsen:

Appreciate it.


Mark Lurie:

And second, I think for context, most of our conversation today is going to be about tax from a US perspective. I know we have some international listeners, but hopefully some other time can do an episode on international taxation, but I don't know much about it.


Patrick Larsen:

US taxes are by far the most convoluted as well, so if you can figure out US taxes, it should be simpler to do the rest.


Mark Lurie:

Okay. Good to know. Great. Well, why don't we start somewhere simple. There's a lot of people who are just going, they're just trading in crypto and DeFi and they're not even thinking about taxes. So what's the first thing that traders need to know in order to start taking taxes into account. Why does it matter to them and what are they taxed on?


Patrick Larsen:

Yeah, sure. I'd say first and foremost, keep good records. you're going to forget that you have that fourth metamask wallet that you just use for some sole NFTs and did like 20 trades on. And that's going to cause like a bunch of havoc three years from now, when you decide to finally file your taxes, when you move back from Puerto Rico to Miami or something. And so I would say it's important to understand that you need to keep your records straight and that you are creating taxable events for yourself. And those taxable events are taken seriously. Governments are around to provide stability and create markets. And then they tax the economic activity that they help create. So they tax the stock market, they tax sales tax, they tax income tax, they tax corporations, they tax things. That's what countries do.


Patrick Larsen:

So your crypto transactions are tax it's like your working activity is taxed and your real estate's taxed and your equities and bonds trades are taxed. There are caveats and there are things to understand and the more you have at stake, the more important it is for you to get good advice generally from your own tax professional and your own legal professionals. You can set up LLCs and trusts and IRAs and you can trade onshore and offshore and everything, if it's all worth it, but compliance costs get pretty high, but the penalties get pretty steep. So it's important to keep in mind that generally when you trade crypto for crypto or Fiat to crypto or crypto to Fiat that's a taxable event, it's a capital gain taxable event, long term or short term capital gain or loss. It's important to remember that when you are staking and you earn income like APY crypto for crypto staking, or crypto for dollar or dollar for crypto, that's income, so you have to report that.


Patrick Larsen:

Selling NFTs is not yet clearly defined, but it's probably something like selling your property or selling a collectible, which is like still a 22% federal tax rate or something. So it's important to keep all those things in mind that the things you are doing are creating taxable events. You can't eat crypto generally, so you have to turn it out to dollars. So you have to go through a KYC to AML portal and that portal's going to have a file on you and it's going to report a 1099 K or some account information to a tax authority.


Mark Lurie:

Got it. And so just for people's context, I think a common thought that a lot of people are having are like, well, DeFi is self-custody and it's kind of anonymous. So what happens if people just don't report or don't pay?


Patrick Larsen:

You can give it a shot, at the end of the day, there's no new things under the sun. So a hundred years ago, when you were trying to hide the fact that you have some wealth or some income from the local tax authority, they would stop by your house. They would just see how you're living. So if you want to keep your gold coins under your house forever and never enjoy them, then you'll never have to pay taxes on them. It's odds are that no one will ever find out about it. And if in 2013 you got some Bitcoin faucet stuff and you send it through Tumblrs and you keep it on a cold storage thumb drive, and you never do anything with it, that's great. But what's the point? Our clients are people who are whales, they're protocol founders, token founders, and they want to pass audits to be on boards.


Patrick Larsen:

They want to command millions in assets and staff up startup funds and buy laptops and chairs and office leases and everything. They're not interested in being off the grid. They're interested in being part of an economic engine and crypto has a higher alpha, and a higher beta for that. If you want to go to great lengths to hide your crypto, maybe you can do it. But it's really tough, because in the end, if you want to buy a gallon of milk or a car or a house, even if you do it with crypto, it's still reported. That stuff is still there. Your car still has to be registered. You still need a license plate. Your house still has to be registered and you're going to pay property tax on it. There's going to be a bill of sale. And even if it was paid in Bitcoin, it doesn't take long eventually for an IRS investigator to be like, oh, you paid with Bitcoin?


Patrick Larsen:

Where'd you get that Bitcoin? What was the cost basis of the Bitcoin? Do you have any capital gains on that Bitcoin? So even if you spend the Bitcoin and don't report your capital gains on it, there's this trail here. It's on chain. It's tied to you through that lease that you paid. If you want to go through a bunch of intermediaries, that's fine, but you're knowingly becoming a federal felon at that point. It's not a game, it's not like a hide the pea under a cup game. It's like, do you want to be like, John McAfee? Do you want to knowingly be a federal felon, because it's frowned upon.


Mark Lurie:

Yeah. Okay. Makes sense. And from the IRS perspective, I guess they can always go back in time and kick up enforcement now for what's happened in the past, but it sounds like they're also taking steps towards being proactive with that. And mean there's some sort of box they check on the most recent tax forms. Can you tell us a little bit about that and how enforcement works and how they think about crypto internally?


Patrick Larsen:

Yeah. I should have the verbiage memorized at this point but I don't, but we can kind of share it in the show notes. But basically it's on page one of the 1040 it's right below your address and your social security number and there's simply a question that asks, check a box, yes or no. Did you transact in digital assets this year? And so that's basically like a perjury trap. You and your tax professional have to answer it. And that starts a record so if later on ... At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency? Pretty broad. Pretty, pretty broad. Intentionally broad. They're starting to learn about this, because it's pretty clear that within a year or two, some central banks are going to issue digital currencies and then that'll start the flood gates for others.


Patrick Larsen:

Maybe it's Singapore, maybe it's South Korea, maybe it's Estonia, maybe it's Russia because they're like, oh, we're out of the global financial system now. Let's go ahead and launch a digital currency. Or it's China with an internal and external separate digital currencies, whatever. Countries can see that economic captivity is going on chain and onto crypto. And they're going to be a part of it. They're going to tax it. They're going to monitor it. They're going to regulate it and they're going to issue it, just like everyone else wants to do so. So this is year one of the largest economy and the most aggressive regulatory and tax body in the world, crushing Lichtenstein and crushing Swiss banking is going after this.


Patrick Larsen:

So in five or seven years, you should expect this to rear its head if you're not complying now. You can move to Puerto Rico. You could put it in an IRA. You can move to Portugal. You could do lots of things to do tax minimization if you want to. But you shouldn't live your life always thinking just about taxes. I think there's way, way more important things to do with your economic output than tax optimization.


Mark Lurie:

So people are taking this seriously and it's complex. Coinbase sends a form and lets you export your trades, but that's just simple transactions. And then there's yields and then there's weird tokens and there's staking and there's all this stuff. Then you have wallets on different chains. It's a massive mess, so it's hard to deal with. And I guess that's what you help with.


Patrick Larsen:

Yeah, absolutely. One of the biggest things that people don't realize is that all of your transaction needs to be priced out to dollars and increasingly all of your economic activities happening on chain, the interesting stuff isn't happening off chain on centralized exchanges. You go into Coinbase, you buy some EVM token and then you leave Coinbase forever. You get into meta mask, you get on those chains and you go and you ape into stuff. You do DeFi, Dow, DEX, NFT stuff and you have no interest in Gemini or Coinbase or anything anymore or Robin hood. And it's a problem for them. So they're trying to figure that out. They're launching NFT marketplaces. They're starting to launch some yield, but it's not the own clones that everyone wants.


Patrick Larsen:

So a lot of your stuff will be on chain. And that means that the transactions will be priced in the units of that blockchain in the token, so it's not priced in dollars. And so you need software to go and price it in dollars, euros, yen, whatever your local taxes are paid in. And there's slippage all the time. There's a difference. Even if you're holding Stablecoin all the time, it's at 99 cents or it's a buck oh one. Sometimes the best investment is tether. It goes is up to a buck oh five and everything else goes down 50%. So you're doing crazy alpha when you're in tether. So these are fun things to think about, but you should kind of realize that the complexity really builds and you have to leak all these transactions from day one through today. And then you have to have software that does last in first out, first in first out, some sort of accounting method that links all together. And that finds your non-taxable self-transfers, because when you send from your own custody to your own custody, that's non-taxable, but you have a gas fee that you can add to your cost base, which reduces your tax liability and then all your holding periods.


Patrick Larsen:

So if you're constantly earning staking tokens, it comes in as income the day you receive it at the market price at the time you receive it. That's income, and then a clock starts on capital gains. If you've held it for more or less than a year there's a different tax rate. And then you have to apply your profit loss in crypto and your income in crypto versus your profit loss in real estate and equities and bonds and everything else and come up with your overall federal tax rate and your tax liability. So it is a bit of a bear and it's not something you should care about, other people should be doing it for you for the most part.


Mark Lurie:

Interesting. Okay. That's amazed. I'm glad there's software for it. So clearly you see all the ins and outs. What are the biggest landmines that people should be worried about? The biggest landmines and missed opportunities? So for example, my understanding is a lot of people in the 2018 ICO bubble on the bear market just became completely underwater in some way. Can you explain that and other similar situations that we should just know about and try to avoid?


Patrick Larsen:

Yeah, absolutely. So there's these kind of liquidity and cash traps that happen. And in 2017, you had all these ICO booms and people are just doubling down. ETH for token, token for ETH, ETH for token, token for ETH. And you just hundred X, your whole stake. So each time you did that in 2017, you were getting income and you're getting capital gains over and over and over again. But since everyone was just doubling down, they weren't taking out cash for their tax liability. They put in one ETH, get back 10 ETH, they put in 10 ETH, they get back a hundred ETH. They put in a hundred ETH, they get back a thousand ETH. They never took anything off the table because they're at like a rigged game. And they're like, oh, I always win. I just like play roulette. I always win.


Patrick Larsen:

And then in January, February of 2018, that wasn't the case anymore. And so when you lose 90 to 99% of your asset, no matter what, you're in really bad shape. Now you have to a hundred X to get back to where you were previously, you have to 10 X to a hundred X just to get back to where you were. So you had all these tax liabilities along the way in 2017. Immediately in 2018, you lost your whole stake. And so even if you sold all your crypto in February of 2018, you couldn't meet the cash tax obligations you had in US dollars for 2017. And that put a lot of people in a pickle. And so they had to reach out to the IRS and come up with some sort of settlements.


Patrick Larsen:

The IRS will work with you. They'll understand, you can't get blood from a turn up. People declare bankruptcy all the time and they kind of deal with settlement programs. They garnish wages. You have to sell some other assets. That's just what happens when you're in the casino. You want to win big, but if you lose big, there's consequences. Crypto is not a, I always win, kind of game. And people are finding that out in 2021 and 2022 as well. There's a lot of volatility. There's rug poles, there's exit scams. There's own clones where the token's going down a lot faster than you'd hoped. There's the Phantom debacle. There's all sorts of stuff that happens and your asset that you think is great, and it's gone up five X recently. And you just keep doubling down, but also doing staking or buying NFTs. Then all of a sudden it goes down 90%, and all of a sudden it's going to be very difficult for you now with $1,000 of Phantom that used to be worth 10,000 to meet your $5,000 US tax cash obligation that you got from all the Dow, DEX, DeFi NFT activity you were doing.


Mark Lurie:

Interesting. We love absurdities on this show. Are there any other particularly absurd stories about individuals or situations which created a tax trap or a tax nightmare?


Patrick Larsen:

I mean, people will just, they'll just forget. I think scientists have done studies of squirrels and they found that squirrels don't actually map where they're burying acorns. They just randomly bury them everywhere, and then they randomly search for them in the spring and they find their acorns and they find other squirrels' acorns, and it just works out, but there's also foxes and owls and stuff taking out squirrels too. It's not like a Cinderella story. So I think that's the biggest thing is people just keep forgetting what they did and where they did it. Our software has algorithms to identify holes. So we'll see cryptocurrency that's coming into your possession from a wallet that you say is not in your possession, or we'll see crypto leaving your possession out to a wallet that have not tagged as in my possession. And we'll say, "Hey, there's a mismatch there." 99% of the time, that's just another wallet you owe and you should just claim that wallet and add your receiving address for that wallet. And then our system will go through and do all the non-taxable self-transfers for you and stitch it back together.


Patrick Larsen:

But otherwise, you're just going to be missing stuff. You're like, oh, I was in Cryptopia, don't know how to account for that. Oh, actually my laptop crashed and the meta mask on it died and now all that stuff's locked away forever. And I can't figure out how to access it. And just all the random stuff happens. Just like if you're storing your cash under a mattress, the cleaning lady could steal it. A fire or tornado could take it out. Life happens to your financial assets. And it's just a lot of random brownie in motion that happens in crypto, because people are just doing so many things so often.


Mark Lurie:

That's so interesting. So let's say you get scammed or you lose your computer and you can't access your crypto. Can you deduct that?


Patrick Larsen:

You can. There's specific rules around it that are a little esoteric and situation dependent. You can claim some losses. Sometimes they'll be at the cost of acquisition. So if you acquire 10 Bitcoin at $1 each and somewhere along the line, you lost it and they're not worth 40,000 for Bitcoin. They're worth like the $10 you paid for it. So that sucks, but I guess in the end, that's semi far, if you think about it. There's a lot of tax scams out there too. So a lot of people have lit their homes and cars on fire or intentionally got them stolen or whatever throughout government history. So there's just a lot of overly paranoid tax rules because there's been so many scams, both ways, it's an arms race. So if these things happen and they are big impacts to you, then you probably should engage a tax professional.


Patrick Larsen:

You can get pretty good advice for are less than 5,000, less than 2,500 sometimes. But the more complex and the higher things are at stake, the more you need good advice. If you're looking at a $20,000 tax bill and you think there's a legitimate way to categorize it, you should probably pay a tax professional, a couple thousand dollars to help you get that straight and also to avoid audit and to keep things clean going forward and to relieve the stress, because how much time is this worth you? If you save 50 hours, a hundred hours of your life, you should be willing to compensate people for that too, I think.


Mark Lurie:

Makes sense. What's interesting about what you said is you're drawing these analogs to the non crypto world. You brick your wallet. Well, that's like money under the mattress and your house burning down. And what's interesting about that is we think of crypto as inherently new and innovative in this undiscovered territory with things no one has ever seen before. And actually, that's not always true. It actually is really similar and completely clear and solved problems, it's actually treated very clearly in the tax code.


Mark Lurie:

We print out NFTs and put them on the wall, for God's sakes, with a frame around it. That is bad [inaudible 00:21:49]. It's hilarious.


Patrick Larsen:

Yeah. Yeah. It's interesting.


Mark Lurie:

Okay. So let's zoom out a bit and try to understand what are the implications of the way this works for markets and understanding markets and also like understanding human behavior. And maybe we start by, tax day is a big thing. Do the markets even move around that? Do you see markets moving in ways that are related to tax?


Patrick Larsen:

There is a lot of talk in public equities and in crypto now of beware December because that's when all the traders will sell because they don't want to look at anything on their books anymore. You're worried about your bonuses. You've like, Hey, my book's made a million dollars profit. I'm going to close out every position. I've locked in my compensation, my bonus and everything for the year. And everyone's already going to start taking vacations. So we're just going to shut it all down. You're going to see very disciplined selling and then maybe some market selling just to get out of positions in December. And some people who are very, very tax conscious, people who have been audited before or are under threat of audit, and they're like, I'm not dealing with this ever again. I'm going to make sure I have the cash to pay it.


Patrick Larsen:

So there is some bubbling about that. I'm sure there's enough market data that you can search for it. There's probably some good research papers about what you should think about in public markets in December. It's not hard to argue that crypto has a very, very high correlation with the NASDAQ right now. And then you may see the same thing in January, February, and March. There's generally, probably just a lot of selling pressure as people file their taxes and then they realize they have some sort of gains and tax liability and they need to get out of some positions.


Mark Lurie:

So one thing I've noticed and I actually know a bit about, so I'll dig into a little is all these people in crypto who go to Puerto Rico.


Patrick Larsen:

Yep.


Mark Lurie:

And so I want to unpack that a bit because it's a little bit vague in why they all do that. And let's call it the Puerto Rico play. Let's talk about that. And I lived in Puerto Rico briefly, so I know good amounts about it. So I'd love to dig into that. And then there's probably two or three other things, which are strange things that happen in crypto, which are actually related to tax, which I think would be fun to dig into if we can find some good examples. Let's start with Puerto Rico. Do you know much about the Puerto Rico?


Patrick Larsen:

I know a bit. I basically it's Puerto Rico residents pay zero taxes on capital gains, dividends, and interest because it's not a US state.


Mark Lurie:

Yes. So my understanding is US is one of the only countries that taxes its citizens on global income, no matter where you live. You have to pay taxes to the US. Now, they'll let you deduct out taxes you have to pay to that jurisdiction, but you have to pay a full share of taxes. And I think this is one reason Eduardo Saverin, the Facebook co-founder, actually relinquished his US citizenship and now lives in Singapore or something because he didn't want to pay taxes on all of that stuff. So the tax code is pretty tight and pretty effective in preventing that. And so the exception is Puerto Rico, because Puerto Rico is not outside the US, it is a territory. And yet it's exempt from the IRS. It defines its own tax code. And so while the territory tax is about 40%, they've established a specific act to encourage international people to move there, which basically says dividend taxes, essentially zero and cap gains is zero, but you have to live there for three years.


Mark Lurie:

And so people move there and they have to buy property. They have to make charitable donations. And then if they do that, then they pay zero cap gains on their taxes. And so that's, I think, why you see a thriving crypto ecosystem in Puerto Rico. And actually, I think it's working out very well for Puerto Rico.


Patrick Larsen:

Yeah, it absolutely is. I think anytime you make your jurisdiction attractive to talented people with capital, that's generally a good thing. People are moving to Puerto Rico, they're buying homes, they're buying cars, they're buying gasoline. They're going to restaurants. They generate a lot of economic activity inside Puerto Rico because there's this Delta. You were going to pay a million in capital gain taxes this year and now you're paying zero, because you're in Puerto Rico. It's not retroactive. So if you move there today and you stay six months, you still owe your 2021 taxes, you just might not owe your 2022 taxes. Please consult a tax professional about that. So I think it's very smart to do. I wish America would do that with a lot of other immigration policies as well. We should just try to attract the most talented people in the world, scientists, doctors, engineers, and then generally people with capital, are pre-entrepreneurial, have higher organizational skills and are pretty effective. And so it'd be good to try to attract them as well.


Patrick Larsen:

And that's why you see capital controls in China. It's because all the talented people are desperately trying to leave. It tells you something about that. And every country does this. America, you have to declare if you're leaving with more than $10,000 of cash, anytime you fly internationally. And in every airport, a beagle comes and sniffs your luggage and it's sniffing for cash. It's not sniffing for meth or drugs.


Mark Lurie:

Oh really?


Patrick Larsen:

Yeah. They don't care. America doesn't care if you leave with-


Mark Lurie:

They care about drugs coming in, not going out?


Patrick Larsen:

Me, as a good Vietnamese kid, knows that you'll have a cash business and then you'll staple a bunch of hundred dollars bills to you and try to fly back to your own country and remit it to your family or buy real estate over the there and not pay US taxes. Obviously, not pay local taxes. They're cash sniffing dogs.


Mark Lurie:

And so money has like a distinct smell, has a distinct smell?


Patrick Larsen:

Linen ink and probably cocaine.


Mark Lurie:

Wow. Cocaine? Because there's cocaine on cash.


Patrick Larsen:

On the cash. There's a joke that like 25% of all cash has touched cocaine at this point because it's always in circulation.


Mark Lurie:

Wow. That's a fun fact.


Patrick Larsen:

Yeah. It's a fun urban myth fact. I don't know if it's real or not.


Mark Lurie:

Okay. So there's a couple other plays. Can you explain this IRA thing I hear about all the time?


Patrick Larsen:

Yeah. So again, you have to match it up to your investment thesis and your cash needs today or in the future. How old are you, all those things. And then there are service providers that will help you establish an IRA that you could put crypto in. Generally, you have to fund-


Mark Lurie:

Just to back up. So an IRA is a tax advantage retirement account that the US has offered to its citizens, the right to create so that they can basically invest for retirement with paying less taxes. And like you can put in, but you can only put in a certain amount a year and you can't withdraw until you're like 67 or something like that. But it grows tax free or there's a Roth IRA, whichever, but that's kind of the idea.


Patrick Larsen:

Right. So there's annual contribution limits and everything. And it's supposed to provide you with a couple million dollars upon retirement that you could live on the rest of your life when you're not earning any income besides social security or something. Some people have seen that as a great way to hedge crypto assets. I think Peter Teal has found a way to protect his venture investments.


Mark Lurie:

Yeah, I've heard he has billions of dollars in his IRA.


Patrick Larsen:

Billions of dollars.


Mark Lurie:

That has grown tax free.


Patrick Larsen:

That's an edge case. Let's focus-


Mark Lurie:

How does that happen?


Patrick Larsen:

I'm sure there's people at the IRS looking into it to see exactly how legal that is and if they have to redress it in some legislation. There's very little legislation surrounding cryptocurrency and so we're fumbling about. The IRS issued some statements in 2014 that gave us a rubric of crypto's like property and so we have to moderate closely and you have to register it. And then there was a law passed in the 2018 tax bill, I believe, that said 1031 exchanges are for real estate only. And that shut the potential loophole of crypto. So since it was called property, you could 1031 exchange. So when I sell Bitcoin for Ethereum, that's non-taxable. That's a 1031 exchange. Now that door's shut. It was never really open, it was just an extremely aggressive, long shot that turned out [crosstalk 00:30:34]


Mark Lurie:

So to clarify, that tax policy, as I understand it, is the US government wanted people who own their homes to be able to move into a bigger home, but if you sell a home and it appreciated, then you got to pay a bunch of taxes, then you can't buy your new home. Yep. And so basically they have this 1031 exemption, which says, if you sell a piece of property and immediately buy something of like kind, then it's exempt from taxation. And I think the real goal of that was people upsizing their homes basically.


Patrick Larsen:

Yeah. Right. Increasing housing velocity, so basically it brings more homes available on the market effectively. It gets people to sell their home. It gets them to sell their starter home and it allows more starter homes to be on the market, up the chain, hopefully.


Mark Lurie:

Okay. And so people tried to apply that to crypto, but it was a little bit of a stretch.


Patrick Larsen:

And then, so back to IRAs. I believe you have to go find an IRA provider that, in their custody vehicle and in their bylaws or whatever, allows you to hold the assets or digital digital assets, and then you will fund that account with dollars and then you'll buy crypto with your dollars inside that account. And now it's a legal fiction. There's no building, that's the IRA building. It's all just like, you're making these transactions where you need to. You create your Coinbase base account, your meta mask with those dollars and they're inside the IRAs protection. What's messy about that is you have a taxable event if you sell your crypto for dollars and then put it in the IRA and then come back out. You've given yourself a taxable event probably.


Patrick Larsen:

And some people are crypto rich, but they're not cash rich. And you can only start with like 6,000 right now. So like, if you have a million dollars in crypto right now, the IRA is not the greatest, it's not that useful to you, but if you love crypto and you really want to make sure you and your kids and whatever are provided for, and you just want to be long crypto or have it as a larger portion of your portfolio, IRAs are really something to look at. Generally, a lot of these vehicles, you need a lot more disposable income than the average American has. It's kind of like a top 10% vehicle. To have an extra 15, 20,000 laying around per year is a great outcome. And so an IRA is definitely something to think about. There's lower cost IRA providers out there. If you find one and you think the costs are too high, shop around. There's definitely people trying to take advantage of you.


Mark Lurie:

Okay. Good to know. And so that seems to be the rub, because you can only put $6,000 a year in, but it grows tax free. And you can exchange it by and sell it tax free, and then you can't take it out to retirement. [crosstalk 00:33:26]


Patrick Larsen:

Pretax dollars. Sometimes it depends on the IRA structure, if it's post-tax dollars or pre-tax dollars. Whereas if you're just investing on Coinbase, those are post-tax dollars.


Mark Lurie:

So. Right. Okay, cool. So regardless, it sounds like the play then is to use your self-directed IRA to invest in things that are likely to appreciate a lot, because those are the ones where you'll have the most cap gains. And so my understanding of what Peter Teal did is he basically bought Facebook stock for a pretty low price. And he was like, well, this is going to appreciate a lot. So he didn't take his self-directed IRA and invest it in a bond yielding a couple percent, he put the Facebook stock invested through his IRA. And so then that appreciates to, I don't know, $10 billion. And now all of a sudden he has $10 billion that he can play with tax free. And so it sounds like with respect to cryptocurrency, let's say you had a million bucks in crypto, putting six grand in a self-directed IRA wouldn't do that much. But if you take that six grand and buy some super long tail coin, and you think that's going to appreciate a lot, then it's actually a tax advantage way to do that. Is that how to understand the Peter Teal situation?


Patrick Larsen:

I think so.


Mark Lurie:

And why self-directed IRAs are so, you hear about them so much in crypto.


Patrick Larsen:

Yeah. It's because someone's selling them that you hear about them.


Mark Lurie:

That's a good point.


Patrick Larsen:

Yeah. It's not that they have incredibly high utility, it's that someone's charging you an incredibly high fee to move a couple pieces of paper around. The marginal cost of them acquiring you as a customer is low, so that's why you're hearing a lot of marketing to them. And they're charging you AUM, I think. Don't sign up for one that charges you an annual fee either, if you can avoid it, because that's going to lot of your gains. So those are a couple things to think about.


Mark Lurie:

You mentioned something about Portugal and offshore. What were those you were referring to?


Patrick Larsen:

So I believe Portugal has also kind of done a Puerto Rico-like thing where they say, hey, all crypto gains are tax free because they want you, as a talented tech or finance person and your crypto holdings, to come into patrol. What are you going to do, you're going to sell some crypto to buy a house. You're going to sell some crypto to set an office. You're going to sell some crypto to buy a car and move about town and support the local economy. Portugal's had a rough go since whatever, the 1600s, I think is the last time Portugal's been having a good run. So that's what Portugal is doing. And that's what small countries should do, especially small countries with great weather and great food. They should be trying to attract people.


Patrick Larsen:

Because otherwise, if you're born in Portugal, say 20 years ago, you're born Portugal. You're a very talented individual. What do you do? You move to London, you move to Madrid. You move somewhere with much higher economic activity for you as a talented individual. And it's the same thing in the United States, if you're born in, sorry, no offense, rural Oklahoma, you're going to move to Stillwater or Chicago, somewhere. You're going to move away from a place where you are not rewarded for your talent and hard work to a place where you're better rewarded for that. So Portugal's kind of saying, hey, you can run your crypto empire from anywhere, run it from Portugal, instead of getting taxed on all this stuff you do. And you are going to run it anyway, you're going to run your token foundation from somewhere in the world. Why not run it from somewhere great like Portugal and keep 30% more of all of your crypto and be able to compound that. That's the other thing to consider is that if every year you're losing 30% of your gains, you're losing a massive amount of compounding over five and 10 years.


Mark Lurie:

I see. And so Portugal doesn't really help the US taxpayer because that's separate from the Puerto Rico situation. But if you're a European, you move to Portugal and you get basically similar benefits.


Patrick Larsen:

It helps anyone who wants to become a Portuguese citizen. Which you could have been born in America, you could have been born in Spain.


Mark Lurie:

Oh, I see.


Patrick Larsen:

But you have to move.


Mark Lurie:

I see. Okay. Got it. Yeah. Got it.


Patrick Larsen:

I think that is mostly the deal. I think it's much easier if you're already an EU citizen, you can just pick up and move to somewhere else in the EU today. Americans have more hoops to jump through, but still something to look at.


Mark Lurie:

Yeah. Interesting. And then now that I think about it, this is all coming together for me now because Miami is another crypto hub. And what's the benefit of Miami, well, no state income tax. And I presume no state cap gains either. And you don't have to live somewhere for a few years, you can just move there right away and claim the benefits. And so if you're in San Francisco or New York, and you're in crypto and you've had a lot of gains and maybe you just move to Miami. And what do you know, there's a huge emerging crypto scene in Miami. And it's so interesting, this really is all coming together for me now because there's so much debate in crypto about like, well, crypto's global.


Mark Lurie:

It doesn't just have to be in Silicon Valley. But on the other hand, it's kind of surprising that it's not because every other tech ecosystem is pretty remote and is pretty Silicon Valley based. And then in New York, that's the finance hub, so you'd think that a lot of DeFi would be there and there is, but ultimately only in crypto, do you see these huge centers arising in all these other areas of the world, Portugal, Singapore, Miami, San Juan, and a big part of the reason is tax, because there's been so many gains. That's so interesting.


Patrick Larsen:

Yeah, yeah. I would say that all the money printing has resulted in the power shifting from capital more to labor again, because even if you're a hedge fund manager, you're still labor. No one likes to think about it. If you're a non-founding CEO, even if you're a founding CEO, I'm still labor. I don't get to control the board and make capital decisions. The fact that there's so much cash chasing so few talented people that can actually earn a return on invested capital makes it so that you can make some demands now. If you're a great trader and you have to live in New York, you're like, look, my investments don't depend on insider trading, so I don't need to be in New York City plying people with drinks to get some tips.


Patrick Larsen:

I can just make these trades effectively from Miami or Omaha or the Bahamas, so I'm going to move there. And you're going to keep me because I'm a better trader than anyone else. My T1 line or my Star Lake is perfectly sufficient or my trading strategy is. Most people didn't grow up in New York, they moved to New York to make money. And so you're only moving to New York to make money. If you can move to Miami to make money instead from Atlanta, Virginia, LA, whatever, why not? The weather's better, the food's better. The real estate was cheaper if you're willing to drive out a little bit. But I think you're also moving to Miami to not have a commute. So there's just a lot of reasons to kind of evaporate New York's concentration of capital and labor over time.


Mark Lurie:

Yeah. Especially in the post-COVID world.


Patrick Larsen:

Yeah. Every company had to get these remote workplace policies until you couldn't say we can't anymore. Three years ago, you'd be like, hey, I'm going to spend three months a year in Miami from the trading desk. And they'd be like, absolutely not. It'll kill morale, everyone else will want to, our profits will go down, but now it's all been done. And it's very hard to put the genie back in the bottle, because if you, as an employer, don't have that friendly policy, one of your competitors will, and your talented people will just switch.


Mark Lurie:

Interesting. I think it's a good thing that the power is back in labor.


Patrick Larsen:

Absolutely.


Mark Lurie:

Interesting. And this also creates a kind of once in a decade or, honestly, once in a generation opportunity for some of these cities to create an ecosystem. There's this moment in time where crypto is boomed, creates lots of these gains, and some jurisdictions are being very smart about having very favorable tax policies to attract them now. Boom, all of a sudden they have an ecosystem there and ecosystems are very path dependent. You get a bunch of crypto people in Miami, all of a sudden Miami has a whole ecosystem. And then it's not going to go away because it's a center of talents and capital and insight, same reason Silicon Valley has been so sticky in the tech ecosystem. And so it's really an opportunity for these governments, through tax policy, to drive long term economic developments in their local economies, which is really interesting and really smart.


Patrick Larsen:

Yeah. There's a cost to acquire a citizen in marketing parlance. And Miami's paying you in tokens, Miami Coin to come to town. And you should, if you're a city and you know people are going to living there, pay their moving costs. Cities all the time will give incentives to an employer like, oh, you're going to move a thousand people here? Here's a $10 million tax break for five years. Oh, you want some zoning done so that you can build a parking lot over there? Done. All these things happen so that you can bring talented people and capital and economic activity to your city.


Mark Lurie:

That's true. They do that for businesses all the time. But you don't hear them doing it for people quite as much.


Patrick Larsen:

No, no.


Mark Lurie:

Look at all these stadiums, they give tax breaks, Amazon's bidding out tax deductions for its headquarters.


Patrick Larsen:

HQ2 was nothing more than a tax shake down. They knew they were going to put that headquarters in Virginia. There was no need to put it anywhere else. There was never going to be an HQ two in Ohio or Maine or whatever. It was always going to go to DC and that was just a shakedown.


Mark Lurie:

So interesting. Okay. Well Pat, thank you so much for sharing your insights and knowledge with us today. This has been such an interesting and eye-opening discussion, which tax doesn't have the best rap for being interesting, but I found this fascinating. So thank you very much for joining us. And we'd love to hear, for the audience, where people can follow you, learn more about you and your company.


Patrick Larsen:

Yeah, sure. So visit us at Zen ledger. So Z-E-N-L-E-D-G-E-R.io, zenledger.io. Or find us on Twitter @ZenLedgerIO, or find me on Twitter @PatrickLarsen. L-A-R-S-E-N.


Mark Lurie:

Awesome. Well thank you, Pat. We really appreciate it, again.


Patrick Larsen:

All right. Cheers. Thanks, Mark.

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