As a contemporary investment, digital currency, also known as cryptocurrency, is still a novelty. However, fresh prospects arise for investors to broaden their knowledge and expand their horizons in this asset class. An imperative aspect that cryptocurrency investors should be familiar with is the option to retain these currencies in a self-managed retirement account, such as a Traditional IRA or Roth IRA.
You may have the question, “What are the advantages of keeping my cryptocurrency in an IRA, and why would I do so?”
There are three advantages to storing cryptocurrency in a self-directed IRA, though the specific benefits will differ from investor to investor based on individual priorities.
What Are Bitcoin and Cryptocurrency IRAs?
To begin, it is important to understand the concept of cryptocurrencies. Essentially, they are electronic currencies that rely on blockchain technology to maintain decentralization and anonymity.
Cryptocurrencies are distinct from fiat currencies, such as dollars, pounds, and euros, in that they are generated through mining efforts involving numerous people utilizing various computer systems around the globe, rather than being regulated by a central authority.
Cryptocurrency transactions are recorded on a distributed ledger, and each transaction forms part of a block which is connected to other blocks — hence, a blockchain. Each party to a transaction is represented by a public key, a series of codes, maintaining their anonymity. Since transactions are publicly available, they can be verified by the parties involved and others.
Bitcoin and Bitcoin IRA
While there were earlier attempts at creating cryptocurrencies, they failed to gain traction until bitcoin emerged in 2009 and achieved unprecedented success. This gave rise to the development of other cryptocurrencies. Currently, the global market for cryptocurrencies is valued at $2.14 trillion, as reported by Coin Market Cap.
Bitcoin originated as a virtual currency, but due to the restricted amount (being unable to exceed 21 million BTC in circulation) and the lack of a governing body to manipulate the quantity, numerous supporters view it as a reliable means of asset preservation: as demand escalates with a fixed supply, the value will increase.
The adoption of Bitcoin as a mode of payment by the Electronic Frontier Foundation resulted in its value skyrocketing from $1 on February 9, 2011, to $1,237 in December 2013, thereby vindicating the optimism of its supporters.
Numerous individuals have earned millions from it since its inception, and on November 10, 2021, the value reached its highest point at $68,789.
SoFi states that since February 2011, the price has increased by 4,738,468%, compounding annually between 100-200%.
In contrast, the S&P 500, which comprises the top 500 US stocks, increased by only 250% over the same timeframe. At the moment, bitcoin’s market capitalization stands at $896 billion, ranking lower than only Apple, Microsoft, Amazon, Alphabet, and Tesla.
As a result, an increasing number of investors are contemplating the incorporation of bitcoin into their self-directed IRA, resulting in the emergence of the concept of a “bitcoin IRA.” Basically, a bitcoin IRA is a type of self-directed IRA that incorporates bitcoin as one of its investment options.
3 Benefits of investing in cryptocurrency in an IRA
1. Potential tax advantages
The tax repercussions associated with cryptocurrencies may be overlooked by novice investors, while seasoned investors may recall their initial response to the issue. In terms of taxation, cryptocurrencies are regarded by the IRS in a manner that is comparable to property.
The government instituted retirement accounts like the Traditional IRA or Roth IRA, which offer tax advantages to aid people in saving for retirement. With adherence to IRS regulations and account stipulations, investments made in these accounts can experience either tax-deferred or tax-free growth. This is a noteworthy advantage of using an IRA for cryptocurrency investment.
One of the main distinctions between a Traditional IRA and Roth IRA is whether the contribution is subject to taxes before or after payment.
When it comes to a Traditional IRA, the account holder can make contributions before paying taxes. This permits them to take a tax deduction before putting money into the account, which implies that any funds inside the account will defer taxes and only be taxed upon withdrawal.
In a Roth IRA, the account holder pays taxes on contributions upfront, which excludes them from getting a tax deduction on contributions. Nevertheless, if all regulations are adhered to, no taxes are imposed on the cash or assets when withdrawn.
Equity Trust allows investors of digital currency to keep their cryptocurrency assets in a Roth IRA or Traditional IRA.
2. Short-term/long-term capital gains tax savings
Unless the asset is held in your IRA, cryptocurrency, along with stocks, bonds, and mutual funds, is generally subject to short-term and long-term gains tax.
Reporting individual transactions for short-term or long-term gains within your IRA is unnecessary because IRA funds are tax-free or tax-deferred, thus removing the need to monitor cost basis for each purchase and sale.
As previously stated, the IRS views cryptocurrency in much the same way as real estate and made reference to this in Notice 2014-21, wherein it was affirmed that “for US Federal tax purposes, virtual currency should be regarded as property.”
It is important to note that earnings from the sale of cryptocurrency investments such as Bitcoin or Ethereum are liable for short-term taxes or long-term capital gains rates, akin to those for real estate investments. If the investment appreciates considerably in value, it could attract taxes from the IRS, unless it is held within a Traditional or Roth IRA.
3. Portfolio diversification
Investing in cryptocurrency through an IRA can provide the advantage of adding diversity to your investment portfolio. With Equity Trust, it is possible to invest in various assets like real estate, private entities, promissory notes, precious metals, and more, using a single account.
How To Include Bitcoin in a Self-Directed IRA
Having been informed about the advantages and disadvantages, the decision is now yours to make. In case you choose to proceed, there are procedures you can follow to incorporate cryptocurrency into your self-managed IRA investment.
- Find a Custodian
- Every IRA must have a custodian, and cryptocurrency IRAs are not exempt. The aim here is to find a custodian that allows you to purchase cryptocurrencies and then evaluate the available custodians to get the best value for money and best fit for you.
- Create an LLC or Invest Through a Broker
- Once you have found a custodian, you have two broad options for purchasing your cryptocurrencies.
To begin with, it is possible to establish a limited liability company known as LLC using your IRA, which is referred to as a checkbook IRA. In order to pursue this option, you must complete the following mandatory procedures:
- Open a checking account for your IRA LLC.
- Use your IRA LLC name and tax number to open an account on a crypto exchange.
- Transfer money from the checking account to the exchange.
- Purchase the cryptocurrencies of your choice.
One option for buying cryptocurrencies is to register your LLC on platforms that offer crypto ETFs or trusts, as an alternative to purchasing individual cryptos on crypto exchanges.
You have the option to acquire cryptocurrencies via a broker, who will handle all the necessary tasks in exchange for a fee. You simply need to generate orders for implementation.
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