The cryptocurrency traders who made huge fortunes last year may be new money, but they face the same question that has bedeviled rich guys for generations: How to avoid paying taxes.
As a solution, some are attempting to take advantage of a controversial tax incentive in Republicans’ 2017 major tax legislation — specifically, by investing in “opportunity zones,” which were sold as a plan to buoy the poorest American neighborhoods but have evolved into a way for wealthy investors to funnel billions in untaxed profits into virtually any venture they choose.
The law allowed companies and investors to delay and reduce their capital gains taxes after they sell a financial asset like stock, so long as they invest the money in a new project located in one of thousands of struggling American neighborhoods designated as opportunity zones. If the investment lasts for more than 10 years, the profits from the new business are completely tax-free.
Investors face few requirements to prove that their projects will create jobs or housing for a community’s existing residents, and scores of them have taken advantage of opportunity zones to erect high-end hotels and luxury real estate in gentrifying neighborhoods.
Crypto investors — whose profits are subject to the capital gains tax of nearly 40% — are making their own run at using opportunity zones by investing in energy-intensive crypto mining operations in rural places around the country.
“It’s a perfect fit,” said Blake Christian, a Utah accountant who specializes in opportunity zones and has a newfound clientele of crypto investors. “They’ve just had this big windfall and invariably they’re looking for a way to save some money because they’re about to get drilled on short term capital gains taxes. And they want to keep rolling the dice” by staying invested in the crypto market.
Fifteen or 20 clients of Christian’s clients, who have made money in the low seven-figures mining or trading cryptocurrency, have set up warehouses in opportunity zones full of powerful computers that solve equations in order to “mine” cryptocurrency and lease the computing power to other customers.
The ideal location for a crypto mine is close to plentiful, cheap electrical power — of which many rural opportunity zones have plenty. One of Christian’s clients is setting one up next to a Texas oil field that has promised bargain-basement rates on natural gas. Another client’s startup has a similar arrangement with a solar power provider.
Yet another client isn’t mining in the United States at all, but in a South American country where energy prices are even cheaper. Through some baroque accounting, which involves setting up an affiliated management company that is located inside an opportunity zone, Christian believes his client will still be able to qualify for a giant tax subsidy.
To skeptics of opportunity zones, that’s the kind of tortured accounting that puts the lie to the whole program.
“Any investment that neither creates jobs nor has any economic spillover into the community is not what the proponents of opportunity zones said they were trying to accomplish,” said David Wessel, a senior economics fellow at Brookings. If it’s possible to run a cryptocurrency mine with just a few local caretakers while the real brain trust lives far away, he said, “Do we really want to use the tax code to encourage these activities, just to make a few people rich?”
Tom Frazier’s company, Redivider Blockchain, is raising money to manufacture prefabricated, moveable data centers that can be plunked down anywhere in the country; he sees opportunity zone status not as a black mark but as a political opportunity. He argues that by setting up shop in opportunity zones, crypto businesses could generate crucial goodwill around an industry and technology still facing widespread derision and skepticism.
“We’re creating jobs where Americans need them,” he told HuffPost in a recent interview.
Frazier said opportunity zones have gotten a reputation as a boondoggle because the vast majority of investments have involved glitzy, one-off real estate projects. Data center businesses could support tech and manufacturing jobs at locations all over the country, he said.
Redivider — which does not exclusively work with crypto miners — has operations in opportunity zones in New Hampshire and the Columbia River basin in Washington state, and the company recently entered a deal to provide all of the computing power for a Bitcoin mine in Homestead, Florida, that will draw 10MW of electricity from the city-owned natural gas plant, or enough to power several thousand residential homes.
“Do we really want to use the tax code to encourage these activities, just to make a few people rich?”
Its investors are a mix of traditional types who sold assets like stock portfolios and new millionaires who made a fortune trading cryptocurrency.
Among those especially eager to invest in Redivider were a couple of crypto traders who had moved to Puerto Rico for its generous tax laws but had misunderstood how far those tax breaks would take them. Residents of Puerto Rico famously don’t pay capital gains taxes, but for cryptocurrency investors, that doesn’t apply to any value the currency gained before they changed their residency. Investing in an opportunity zone will get them part way off the hook.
One of the advisers to Redivider, Daniel Kowalski, helped write the Treasury’s opportunity zone rules under former Secretary Steve Mnuchin.
Without saying how much exactly the fund has raised, Frazier said he expects it to reach or exceed its goal of $250 million by the end of March.
Critics say there’s nothing wrong with ambitious business — just that they don’t require giant federal tax breaks.
“Why are we taking forgone taxpayer revenue and subsidizing this, of all the things we want to spend our nation’s money on?” said Brett Theodos, an Urban Institute senior fellow and skeptic of opportunity zones. “Is crypto mining a bad thing? Maybe yes if you’re the environment, maybe not for an individual community. But is it something we need to be subsidizing, as the federal government, in order to produce? I’m not clear why we’d want to do that.”
On that point, Frazier said he doesn’t disagree. He “100%” would have founded a data center business with or without opportunity zones, he said.
“Don’t get me wrong though, it’s a great benefit,” he said. “There’s nothing harmful about doing good and doing well at the same time.”
Critics have been asking for years whether the opportunity zones program is creating enough jobs to be worth its soaring price tag.
Since Congress created the program in 2017, it has been used to fuel hundreds of real estate projects by and for the rich, especially in neighborhoods that are undergoing rapid gentrification. In 2019, just 16% of opportunity zones attracted 100% of investments, about half of which were investments in real estate, according to University of California, Berkeley, researchers Patrick Kennedy and Harrison Wheeler. Those zones were low-income relative to the rest of the country but were more likely than other opportunity zones to have undergone recent income and population growth and demographic change — a sign that new investments were not catered toward longtime, poorer residents but toward newly arrived gentrifiers. The country’s other 84% of zones — more than 7,400 — attracted $0 in investments.
A ProPublica investigation found that a Florida developer whose family members are major political donors helped hand-pick one of the state’s opportunity zones: a neighborhood in which he was poised to erect several luxury apartment towers and a super yacht marina. Last month, Senate Finance Committee Chair Ron Wyden (D-Ore.), launched an inquiry into a bevy of high-end developments that have claimed the opportunity zone tax break without appearing to have any benefits to the existing neighborhoods.
“The broader issue with opportunity zones is, my goodness, what an inefficient and circuitous way to subsidize local communities,” Theodos said. “Rather than run it through an opportunity zone fund, you could just give them the money.”
There’s no way to know which businesses are relying on opportunity zone tax breaks unless they announce it themselves. Congress did not require anyone investing in an opportunity zone to publicly disclose their investments, and a bipartisan effort to require more disclosure has stalled.
But it’s clear that many crypto businesses are at least testing whether they can take advantage.
“There’s nothing harmful about doing good and doing well at the same time.”
Argo Blockchain, a publicly traded cryptocurrency mining company headquartered in London, recently broke ground on a billion-dollar mine in an opportunity zone in Dickens County, Texas. The mine will get cheap and plentiful power from a wind energy substation located next door — but Peter Wall, Argo’s CEO, said it was just as important that the property was located within an opportunity zone.
A few weeks after construction started, a Dallas attorney gamed out several ways the mine could operate through an opportunity zone fund, according to a powerpoint presentation shared with HuffPost.
A company spokeswoman claimed that Argo Blockchain may have explored the idea of becoming a qualified opportunity zone business but that it ultimately decided against it. As for why Argo ultimately did set up shop in an opportunity zone, she said, “it is more of a coincidence than a driver of the decision.”
Other attempts have been more hapless. Bit Capital, which proposed building a $50 million crypto mine-for-lease powered by cheap hydroelectric energy in an eastern Washington state opportunity zone, attracted zero investments, one of the co-founders, Jimmy Odom, told HuffPost.
Crypto mines may be closer to the original intent of opportunity zones than luxury housing or storage units. For one, they are more likely to be located in rural counties that have missed out on the vast majority of opportunity zone investment — and they do create employment. Judge Kevin Brendle of Dickens County, Texas, where the Argo mine is located and which is trying to lure additional crypto businesses, said that even a handful of new jobs counts for a lot in a county of barely 2,000 people.
But they might also test the limits of the law. “It’s a wide open playing field until you get shut down.” said Jessica Millett, who chairs tax practice for the New York law firm Duval & Stachenfeld.
She and others are skeptical that the IRS will buy into cryptocurrency startups using opportunity zone tax breaks.
For one, a business started in an opportunity zone has to pass several tests in order to prove it’s an actual business and not just a souped-up tax shelter. But the IRS hasn’t defined cryptocurrency with enough detail for some crypto ventures to be sure they will pass muster. One test, for example, asks what share of a business’ assets are debt. If a business is running DeFi protocols, which can be used to lend cryptocurrency, does the IRS consider them to be in the business of debt?
“These are the kinds of things tax lawyers stress out about,” Millett said.
Another rule the IRS imposes on opportunity zone ventures is designed to weed out businesses that can jump through the law’s technical hoops but still obviously flout the spirit of the law. Known as the anti-abuse rule, it essentially asks, “Come on, seriously?”
Millett and other tax advisers believe the anti-abuse rule could ensnare crypto businesses, which employ a couple of local caretakers — construction workers, security guards, electrical engineers — but whose most crucial employees live far away.
“I do believe that when the [IRS] examines cryptocurrency opportunity zone ventures, they’re going to do it with a skeptical eye. I don’t think they’ll be amused,” said Matthew Rappaport, a New York tax attorney at Falcon Rappaport & Berkman. “The program was not invented for these things. You’re just tempting fate.”
Finally, the most lucrative feature of the program is that any profits the investments generate are not taxable — after 10 years. As tax shelters go, it’s only worthwhile to use the opportunity zone structure if the business actually makes money and lasts that long.
Last month, the world’s largest cryptocurrency lost half its worth and the total cryptocurrency market lost $1 trillion in value.
To Rappaport, anyone who claims they have a surefire 10-year plan is kidding themselves.
“The people who have a really firm grip on this world understand it is moving way too quickly.”