36 Chambers of Crypto Taxes Series
32nd Chamber: Holding Cryptocurrencies in Self-directed IRAs
Why the series title?
I’m a huge Wu Tang Clan fan. Their first album was named Enter the Wu-Tang (36 Chambers). This album changed my life and hip hop forever. It is my goal to change the way complex tax and business issues can be explained to the masses.
What is a cryptocurrency?
Cryptocurrency is a digital currency that uses encryption techniques, rather than a central bank, to generate, exchange, and transfer units of currency. Unlike cash transactions, no bank or government authority verifies the transfer of funds. Instead, these virtual transactions are recorded in a digitized public ledger called a “blockchain.” Individual units of the currency are called “coins.”
“Death, taxes and childbirth! There’s never any convenient time for any of them.”― Margaret Mitchell
An Individual Retirement Account (IRA) is an account set up at a financial institution that allows an individual to save for retirement with tax-free growth or on a tax-deferred basis. There are several different types of IRAs and each type have different tax benefits. The tax benefits allow your savings to potentially grow, or compound, more quickly than in a taxable account. Did you know that there is a way to hold alternative investments like cryptocurrencies in an IRA? Cryptocurrencies are normally prohibited from holding in regular IRAs. Traditional IRAs and Roth IRAs can only hold securities like stocks, bonds, certificates of deposit, and mutual or exchange-traded funds (ETFs). However, the IRS clarified that cryptocurrencies are taxed as property so they can be held in a properly set up self-directed IRA (SDIRA). Let’s talk about it!
It is always good to start with the basics. It is very important to know the differences of each type of IRA. Traditional IRAs allows pre-tax contributions to grow tax-free until withdrawn (taxes are paid only at the time of withdrawal). Funds contributed to a traditional IRA can also be deducted on a tax return in certain cases. Roth IRAs allows post-tax contributions (you pay taxes now) that then grow in your retirement account tax free (if you meet certain criteria). In this case there are no extra tax deductions. With a Rollover IRA, you can contribute money “rolled over” from a qualified retirement plan into traditional IRA. Rollovers involve moving eligible assets from an employer-sponsored plan, such as a 401(k) or 403(b), into an IRA.
SDIRAs are directly managed by the account holder. Therefore, the responsibility of the investment and the due diligence fall solely upon the account holder hence the name “self-directed.” SDIRAs are only available through specialized firms that offer SDIRA custody services. Self-directed IRAs are retirement accounts that allow the holder to have alternative investments such as precious metals, commodities, real estate, and other sorts of alternative investments — including cryptocurrencies. An SDIRA can be funded by transferring money from a Traditional IRA or a Roth IRA. This is a form of a rollover IRA.
The most important step in opening an IRA is to select the option that fits your individual investment style. It’s important to know that application instructions vary based on the type of investing style you choose. An IRA contribution is money you contribute to a traditional, Roth, or other type of IRA in order to save for retirement. There are annual limits to how much individuals can contribute, and certain contributions may be tax-deductible, depending on the account owner’s income and employment situation. In order to trade cryptocurrency tax free within a self-directed IRA, the steps are:
1. Open and fund a traditional or Roth IRA with US dollars (USD)
2. Rollover the USD from the traditional or Roth IRA into a self-directed IRA
3. Buy/trade cryptocurrency from the USD in the self-directed IRA
Know the risks involved in SDIRAs:
- Make cryptocurrency investments only after thoughtful consideration of the impact on your retirement needs and risk tolerance. Cryptocurrency valuations are hit with wide price swings making it a very risky venture for retirement savings. I wouldn’t recommend doing it if you are very close to 59 ½ years of age or approaching retirement.
- Self-direct IRA accounts usually come with high maintenance fees. A firm may charge a minimum monthly account fee and a percentage of the account balance as a holding fee. There are additional charges linked to the account opening, to asset purchases, and fees for fund transfer which you should be aware of as they can be very high. There are several options of companies. Make sure to take your time to compare all options before choosing one.
- To maximize the benefits, you must hold off on withdrawing the funds until you reach 59½ years of age.
- Make sure to trade with a reputable SDIRA custodian. Do your research and start with a very small contribution amount. Identity thief is a real worldwide problem. In order to open an account you must give sensitive information so choose wisely.
- IRAs are very complicated but may be worth the significant tax benefits. Factor such as age, annual income, retirement goals, tax bracket, and martial tax filing status play roles in the effectiveness of SDIRAs. Make sure to have a conversation with not only a financial adviser but also with a tax consultant.
Until next time……Blockchain 4 The People!!!!!
Need help with your crypto taxes? Contact me at jamaal@jstaxcorp.com
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