The IRS has made it clear in IRS Notice 2014-21 that cryptocurrencies will be treated as property for federal income tax purposes. Just like stocks, mutual funds and real estate, cryptocurrencies may be purchased with IRA or 401(k) funds. The question is: if one is interested in using IRA funds to purchase cryptocurrencies, how can you do it?
All IRA accounts are held for investors by custodians. These may include banks, trust companies, such as IRA Financial Trust, or any other entity approved by the IRS to act as a trustee or custodian. A Self-Directed IRA is an IRA held by a custodian that allows for a broader and more diverse set of investments than is permitted by traditional IRA custodians. Self-Directed IRA custodians will allow investors to invest retirement funds in other types of assets such as real estate, promissory notes, private placement securities, and even Bitcoin.
Before one decides to purchase cryptocurrencies, such as Bitcoin, with a Self-Directed IRA, there are three main items to keep in mind:
Control Your Own Private Key/Key Control
There are generally two ways to purchase cryptocurrencies with a Bitcoin IRA: (i) The Bitcoin IRA Broker/Custodian Controlled approach, and (ii) the Wallet Control IRA LLC solution. Both structures have some advantages and disadvantages.
With the Bitcoin IRA broker approach, once the cryptocurrencies have been purchased by the broker, they are stored in a digital wallet, which typically requires multiple signature verification. However, the IRA investor does not control the cryptocurrency wallet or the associated private key. Furthermore, selling or exchanging the cryptocurrency requires interaction with the broker and usually cannot be done online. Lastly, there are commissions imposed on each side of the transaction.
On the other hand, with a Wallet Control Bitcoin IRA LLC, the Self-Directed IRA is invested into a newly established Limited Liability Company (LLC) that is owned by the IRA and managed by the IRA holder. The IRA LLC will then establish a cryptocurrency exchange and link the exchange account to the new IRA LLC account. The IRA holder will have the power to purchase and hold the cryptocurrencies online or via a digital or hard wallet. The IRA holder, as manager of the LLC, will have control over the private key associated with the IRA LLC-owned cryptocurrencies.
Know What the Fees Are
With the Bitcoin IRA Broker/Custodian Controlled approach, the IRA investors must purchase the cryptocurrency through brokers associated with the Bitcoin IRA facilitator. The cryptocurrencies are typically purchased by phone and the investor is limited too investing in what is offered by the broker. The broker will typically charge commissions between 10%-25% for the purchase and sale of the IRA owned cryptocurrencies. Whereas, in the case of the Wallet Control IRA LLC, the IRA holder will have the ability to purchase and sell cryptocurrencies on any exchange of his or her choosing, allowing one to have more control over the costs involved. Most cryptocurrency exchanges charge transaction fees of between 0.15-2%. Considerably less than brokers!
Factor in the Risks Involved & Nature of the Cryptocurrency Market
Whatever platform you decide to use, it is crucial that investors understand the financial risks. Bitcoin IRA investors should have the financial ability to bear the risks of a cryptocurrency investment, and a potential total loss of their investment. Cryptocurrency investments, such as Bitcoin, are uncertain and highly volatile. Just look at the rise and fall of any crypto out there, especially Bitcoin.
The cryptocurrency market trades 24 hours a day, seven days a week. For one, the 24-hour market structure requires investors to think about the daily price changes in their positions through a different conceptual lens than their stock portfolios. In the U.S., stocks listed on The New York Stock Exchange or NASDAQ trade during regular market hours, between 9:30 a.m. and 4 p.m. EST.
With the Bitcoin IRA Broker/Custodian Controlled approach, selling or exchanging cryptocurrency requires interaction with the broker only during regular weekday business hours and usually cannot be done online. In the case of a Wallet Control IRA LLC, the IRA holder, as manager of the LLC, will have total control over the cryptocurrencies and can buy and sell the cryptocurrencies 24 hours a day, seven days a week.