Self-Directed IRAs for Crypto — What you need to know!
If you had bought, sold, or otherwise transacted in cryptocurrencies over the last few years, chances are you are liable for capital gains tax.
This is because cryptocurrencies are classified as a ‘capital asset’ by many tax authorities around the world. Fortunately, the proper use of a self-directed IRA can help to minimize future crypto tax liabilities.
Tax Classification for Cryptocurrencies
Cryptocurrencies now share the same tax classification as traditional assets such as stocks, bonds, vehicles and real estate. Many tax authorities do not see cryptocurrencies as a ‘currency’, like banknotes or legal tender (which don’t trigger capital gains).
Rather, the classification of cryptocurrencies as a capital asset means when a cryptocurrency is sold, a taxable event is triggered, necessitating a determination of a capital gain or loss on the transaction.
This tax ruling applies (in general) to most commonwealth nations (including Canada, Australia, New Zealand, UK), most of Europe, and the United States.
Unfortunately, if you have been trading cryptocurrencies in your personal capacity over the last few years, there is not much you can do about the tax liabilities which you have accrued from past transactions.
However, there is a way to safeguard your cryptocurrency investments and minimize your taxable liabilities for future transactions and this can be achieved through what is known as a Self-Directed IRA.
What is a Self-Directed IRA?
A Self-Directed Individual Retirement Account (SDIRA) is a retirement account that can be directly managed by the account holder (you) but requires the account to be administered through a custodian or trustee. A custodian or trustee can be a bank, trust company or any other entity which is recognized by the relevant domestic tax authority.
An Individual Retirement Account (IRA) is best to be thought of not as an investment, but rather as a vehicle (or basket) in which to keep your capital assets. This can include traditional investments like mutual funds, stocks, bonds and property.
The mechanics of an IRA are that it operates through a separate legal entity, such as a limited liability company (LLC). The LLC functions as a distinct legal entity for your investments and is separate from the investor, allowing for preferential tax treatment.
There are many types of retirement accounts including Simple IRAs, Traditional IRAs, Roth IRAs and SEP IRAs. However, these IRAs are generally restricted to only traditional investment types.
Self-Directed IRAs are very similar to regular IRAs, except that they allow non-traditional investment types.
Non-Traditional Investment Types
A self-directed IRA is a special type of IRA account that allows non-traditional investment types — These are investments that fall outside of what would be termed traditional investments such as stock, bonds, certificates of deposits and other common investment types.
Self-directed IRAs allow the individual to directly trade, buy and sell these non-traditional investments (which can include cryptocurrency). However, it’s important to note that these types of accounts do require oversight which comes in the form of a custodian or trustee of the account.
With the increase in interest and growth of the cryptocurrency market and combined with the increasing government regulation, taxation and enforcement, self-directed IRAs have become a very popular investment vehicle for the cryptocurrency investor.
What is a Crypto IRA?
A cryptocurrency IRA is a Self-Directed IRA that holds investments in cryptocurrency and permits the account holder to buy, sell and otherwise freely trade cryptocurrencies within this investment vehicle.
The Advantages of a Crypto IRA
Crypto IRAs allow individuals to diversify their retirement investments by allowing for the inclusion of cryptocurrencies and protecting these investments from taxation until withdrawn from the IRA. This alone can provide tremendous benefit given the increasing taxation and regulation this industry is seeing.
Originally the first crypto IRAs only allowed investors to buy Bitcoin. Today, with more options available for the cryptocurrency investor, Crypto IRAs can also include a much wider selection of cryptocurrencies to choose from. Some Crypto IRAs include the ability to buy and sell any of the top 100 most popular cryptocurrencies (by market capitalization).
The Disadvantages of a Crypto IRA
Crypto IRAs also come with a few disadvantages the investor should be aware of. The potential tax benefits from trading cryptocurrencies through a self-directed IRA do come with their own set of challenges.
The firms offering crypto IRA services are not bound by any fiduciary duties and as such do not provide investment advice nor assess the risks with respect to the investments made.
Also, Crypto IRAs typically incur initial setup fees, yearly maintenance and also may charge anywhere between 1% to 3.5% per transaction. Many providers charge different rates based on the type of transaction. It is typical for providers to charge up to 3.5% (in addition to exchange fees) per purchase and a 1% fee on the sale of the cryptocurrency.
For high-frequency traders (such as day and intra-day traders) the cumulative effect of these fees may negate the potential tax advantages offered by the IRA. It’s for this reason Crypto IRAs are better suited for those with the HODL approach to investing.
Is a Self-Directed Crypto IRA Right for you?
Determining the right investment vehicles is a personal choice and should be done with the assistance of your financial advisor.
It’s important to stress that Crypto IRA trustees and custodians are not subject to any fiduciary duties and as such do not provide any investment advice. As the saying goes, Always do your own research.
For those investors looking to lock in their cryptocurrency investments for the long-term (such as those who HODL), crypto IRAs may be an excellent choice.
Crypto IRAs are just one of many options available for cryptocurrency investors to legally shelter their crypto investments from unnecessary taxation.
With the increasing enforcement, regulation and taxation of cryptocurrencies, finding and using domestic or offshore tax structures to protect your crypto investments is a prudent and wise financial decision.
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