I feel like I might have accidentally ruined my life because I didn’t know about the taxes— Reddit User
Cryptocurrency trading in 2017 reportedly left one Reddit user with a $50,000 debt to the IRS, which he says he’s unable to pay according to his March 14 Reddit post.
This is just one of many stories where individuals are only now learning their Bitcoin and cryptocurrency trading activities have resulted in very large and serious income tax implications.
According to the IRS, cryptocurrency is treated as property; not currency.
This means that each and every cryptocurrency transaction triggers a “taxable event” which may be considered as either ordinary income or generate a capital gain/loss (depending on the type of transaction).
This is not how to trade Bitcoin tax free
Do Not Trade in Your Personal Capacity:
The IRS has made is very difficult for “individuals” to actively trade cryptocurrency due to the seemingly unreasonable classification of cryptocurency as an “asset”.
This requires individuals to record every cryptocurrency transaction, provide details of each transaction (no summary is allowed) on their income tax return.
For day traders, you can imagine this would be a hugely impossible task.
There is a much better method to trade cryptocurrency without having to deal with all these onerous rules.
IRA & Retirement Accounts
An individual retirement account (IRA) allows an individual to save for retirement with tax-free growth or on a tax-deferred basis.
The best part is that cryptocurrency can be included in an IRA portfolio which means two things:
- Capital gains/losses are generally only calculated when funds are withdrawn
- Transaction reporting can be summarized.
This solves two of the biggest problems most people are encountering when they are “investing” into cryptocurrencies in their personal capacity with their after-tax income.
When it comes to IRAs, there are many different flavors and in general there are three main types:
- Traditional IRA: Contributions to the IRA may be tax deductible and the earnings can grow tax-deferred until they are withdrawn
- Roth IRA: Contributions are made with after-tax income and can grow entirely tax-free (some conditions apply).
- Rollover IRA: Can be considered a “Traditional IRA” including additional eligible assets, such as 401(k), 403(b) or employer-sponsored plan.
Additionally, you’ll want to setup a self-directed IRA which will give you the ability and authority to manage the trading of your own cryptocurrencies (without having to worry about any investment or adviser fees)
Offshore IRA & Retirement Accounts
Another option is to take your retirement account offshore. This can be done with an offshore IRA LLC which would be linked to your self-directed account.
The US custodian of the account invests the assets into the LLC and then you are able to manage it yourself and have the added privacy and security of having your funds offshore (in a different legal jurisdiction).
Moving cryptocurrency “offshore” is a relatively easy process.
Because cryptocurrencies are “virtual” — that is they don’t physically reside anywhere, due to this feature — they can easily be “transferred” overseas into your own offshore company.
Now Trade Bitcoin Tax Free (or Deferred)
IRAs offer an excellent vehicle for transacting with cryptocurrencies.
IRAs allow individuals to grow their cryptocurrency investments within a retirement vehicle that can either defer taxes or eliminate them completely (depending on the IRA) and also reduces tax reporting requirements.
Self-Directed IRAs (both onshore and offshore) also give you the ability to manage and control your cryptocurrency investments — so you have full control over your cryptocurrency holdings.
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