Hedge fund managers often encounter tax issues when incorporating crypto assets into their portfolios. This is particularly true for states like New York, Connecticut, and California. In order to incentivize asset managers to relocate to their states, some governments have offered exemptions for out-of-state investors from income taxes. This is because dealing with taxes from a different state can be complex and expensive. Out-of-state investors would need to file a separate tax return and pay taxes in both states, as well as claim a credit for their state tax.

For example, in California, non-resident investors who invest in a hedge fund managed by a family-owned company are exempt from filing tax returns. They only need to pay state taxes if their sole activity in California is their investment in the hedge fund. Additionally, out-of-state investors must ensure that the hedge fund they are investing in has been approved by the state as an “investment partnership.” This term includes various types of securities such as stocks, bonds, foreign currency deposits, mortgages, and asset-backed securities. It also encompasses foreign currency exchange contracts, stock and bond index securities, and futures contracts and options for certain securities, currencies, or financial instruments. The question then arises, where do cryptocurrencies like Bitcoin and Ethereum, which have CFTC-approved futures, fit into this list of “qualifying investment securities?”

Hedge fund managers and advisors may be uncertain about whether cryptocurrencies should be considered investment securities. Some states, like New York, have provided guidelines for treating crypto as property. It may be time for California to establish similar guidance as well.