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for the exclusion under Sec. 933. particularly those who qualify for Puerto deferred recognition of income for stak-
The manager makes the election by Rico tax incentives, can dramatically ing rewards has recently gained traction.
reporting on his income tax return reduce their potential tax liabilities by This discussion considers both sides of
for 2022 the gain in accordance with moving their lives and businesses to this deferred recognition argument so
the source allocation rules in Regs. Puerto Rico. U.S. persons seeking only that taxpayers who receive cryptoasset
Sec. 1.937-2(f)(1)(vi). to minimize or eliminate taxes on un- staking rewards can understand the
realized gains and appreciation in their possible risks and merits of each income
Property other than market- business interests prior to their move tax position.
able securities: For property other may find the U.S. exemption and Puerto
than marketable securities, the portion Rican incentives of little use. The Jarrett case and the
of the gain that can be allocated under The recent IRS campaign will argument for deferred
the election to Puerto Rican sources focus in part on former U.S. residents recognition of gain
depends on the proportion of days over now living in Puerto Rico who incor- A good place to begin to explore the
the entire holding period that the tax- rectly exclude income that is not Puerto taxation of staking rewards is with the
payer is a bona fide resident of Puerto Rican–source income covered by Sec. Jarrett case (Jarrett, No. 3:21-cv-00419
Rico. Thus, the appreciation of the 933. Therefore, U.S. taxpayers who (M.D. Tenn. 5/26/21) (complaint filed)).
asset is spread ratably over the holding intend to take advantage of the tax In May 2021, Joshua and Jessica Jarrett
period, regardless of when the actual benefits of bona fide residence in Puerto brought forward an argument in court
appreciation in value occurred. A bona Rico should evaluate whether their for the deferred recognition of gain
fide resident in Puerto Rico who only anticipated gains on significant sales from staking rewards. In their complaint
recently moved to Puerto Rico can al- or other dispositions qualify as Puerto submitted in a federal district court
locate only a small portion of the gain to Rican–source income excludable under in Tennessee, the Jarretts assert that
Puerto Rico if the holding period greatly Sec. 933. they should be refunded taxes paid on
exceeds the period during which he or From Douglas Borg, CPA, J.D., LL.M. Tezos tokens, the value of which was
she is a bona fide resident of Puerto (Douglas.Borg@rsmus.com), Baltimore mistakenly included in their tax return.
Rico before the sale. Tezos tokens are a type of digital token
The rule for pro rata allocation that relies on a proof-of-stake protocol
for property other than marketable Gains & Losses to validate transactions. The taxpayers
securities can result in distortions. For claimed that the tokens at issue should
example, if most or all the appreciation Cryptoassets: How should be considered created property. They
of an asset occurs during the taxpayer’s proof-of-stake rewards be argued that the tokens did not exist
residency in Puerto Rico, but the hold- taxed? prior to Mr. Jarrett’s participation in
ing period extends long before that Cryptoassets have increasingly proved the staking process (called “baking” on
residency commenced, then much of the to be a significant disruptive force across the Tezos blockchain) and, similar to a
gain will be U.S.-source income even several industries, from financial services traditional baker who has baked a loaf
though the growth occurred after bona to energy and the arts. In this innovative of bread or an artist who has written a
fide residency was established. For such and rapidly changing landscape, legisla- novel, he should not have to recognize
assets that have an extensive holding pe- tors and tax professionals are left trying the staking rewards as income until they
riod over several years before residency to decipher how to tax and report this are disposed of and a realization event
commences in Puerto Rico, this election new asset class. Very limited guidance takes place.
may not provide much relief from U.S. has been provided by the IRS and Trea- The complaint went on to state that
tax liability. sury regarding the tax consequences of the staking rewards were created by Mr.
digital assets, and no guidance has been Jarrett through the proof-of-stake pro-
Significant savings possible provided regarding the tax treatment tocol on the Tezos blockchain and were
While the tax benefits of moving to of “staking” rewards earned through not paid to him by any person as defined
Puerto Rico are attractive, interested a proof-of-stake protocol, which is a under Sec. 7701(a)(1). Fundamentally,
individuals should understand that consensus mechanism to validate trans- the Jarretts argued that there is currently
the benefits primarily apply to income actions on a blockchain (more about the nothing under U.S. law that allows
and activity occurring during residence proof-of-stake protocol later). the U.S. government to treat created
in Puerto Rico. Hence, persons who In light of the lack of guidance property as income. Therefore, staking
can operate businesses in Puerto Rico, from the IRS and Treasury, the case for rewards should not be taxed as income

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