Posted by Abundant Wealth Planning LLC

The Secret to Earning Bitcoin Tax-Free

The Secret to Earning Bitcoin Tax-Free

You’ve probably heard of rumors going around saying cryptocurrency returns are going to be used to fund early retirements. However, there may be one important thing you may have missed. It’s the fact that there is a specific IRA or individual retirement account that allows Americans to hold crypto assets today so they can save for retirement. Any savvy investor would naturally want to take control of their funds. If you are one of those who want to diversify their risk and trade while completely deferring or eliminate income taxes, then you have to pay attention to these types of retirement solutions.

The IRS granted special tax advantages to several types of IRAs. Let’s just say, these plans are made to lower taxes and in turn incentivize retirement savings. Traditional IRAs and Roth IRAs are the two main types of IRAs.

    •    Traditional IRAs - this allows contributions that are pre-tax to grow free from taxes until withdrawn (note that only at the time of withdrawal taxes are paid). In certain cases, funds contributed to a traditional IRA can also be deducted.

    •    Roth IRAs - this allows contributions that are post-tax that then grow in your retirement account free from taxes (as long as you meet certain criteria). There are no extra tax deductions in this case.

IRA That Can Hold Crypto

It’s normally prohibited for cryptocurrencies to hold regular IRAs. Securities like stocks, bonds, certificates of deposit, and mutual or exchange-traded funds (ETFs) are the only ones held by traditional IRAs and Roth IRAs. However, according to the IRS, cryptocurrencies will be treated as property for tax purposes under Notice 2014-21 and they can be held in an appropriately set up self-directed IRA or SDIRA.

Retirement accounts that allow the holder to have alternative investments are called self-directed IRAs. They can be precious metals, commodities, real estate, and other sorts of alternative investments which also include cryptocurrencies. SDIRAs, on the other hand, has been around since 1974, the same time when IRAs were established but they are still considered a new phenomenon to crypto owners.

The account holder manages SDIRAs so the account holder is the only one responsible of the investment which is why it’s named as “self-directed.” Only specialized firms offering SDIRA custody services have SDIRAs.

How to fund an SDIRA

If you want to fund your SDIRA, you only need to transfer money from your traditional IRA or Roth IRA, also known as a “rollover.” The source of traditional or Roth IRA funds usually come from regularly earned income such as wages, investment income, and business income among others.

This means that if you want to trade cryptocurrency without paying taxes within a self-directed IRA, you need to follow the following steps:

    •    Open a traditional or Roth IRA and fund it with USD

    •    From the traditional or Roth IRA, rollover the USD into a self-directed IRA

    •    Buy or trade cryptocurrency from the USD in the self-directed IRA

Taxes on SDIRAs

There are several advantages to SDIRAs. For instance, you trade cryptocurrency in an SDIRA funded by rollover funds. The various scenarios can then happen:

Note: that you can withdraw the original contributions with a Roth IRA at any time tax-free or without penalties.

Here’s the good thing about tax deferral: they compound each year. So, let’s say you rolled over your $20,000 from a traditional IRA to an SDIRA. You bought 2 bitcoins at the age of 25 years old. Assuming that the price of bitcoin increases at 10% each year and you took out the funds at age 71, you would be able to defer over $2 million in taxes assuming a tax rate of 15% on average.

Yes, the IRAs can be a complex area of the tax code but they do have some great tax benefits. For cryptocurrency holders, there are several platforms that offer self-directed IRA accounts. Look into trading with a reputable SDIRA custodian if you’re a savvy investor who plans to build crypto wealth while mitigating taxes. If you want to maximize the benefits, just keep in mind that you need to hold off on fund withdrawals until you reach 59 ½ of age. Lastly, consider consulting a financial advisor or a tax professional to make sure you’re not missing any benefits in dealing with crypto.

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