Cryptocurrency is a form of digital money that’s meant to be secure and, in many cases, anonymous. It is a digital currency that uses cryptography. Cryptography is the process of converting legible information into an almost uncrackable code. As a result, this tracks purchases and transfers.
Bitcoin has become the leader in shepherding in a wave of cryptocurrencies built on a dispersed peer-to-peer network. Today, it is the standard for cryptocurrency. The digital currencies that came after Bitcoin are Altcoins. Altcoins have attempted to be the improved version of Bitcoin. Although some of these forms of cryptocurrency are easier to mine than Bitcoin, there are trade-offs to consider. This includes greater risk brought on by a degree of lesser liquidity, acceptance and value retention.
Some of the more popular types of cryptocurrencies aside from Bitcoin are:
- Ethereum
- Litecoin
- Ripple
- Zcash
- Dash
Bitcoin Mining
Many people wonder how and who creates Bitcoins. This happens through the process of Bitcoin mining. “Miners” add transactions to Bitcoin blocks that they find. They add the transactions in chronological order. As a result, if you use bitcoin, you can never use the same Bitcoin twice. Finding new blocks is somewhat of a guessing game. In other words, miners make guesses on which blocks are new, and rarely do they succeed the first several times. When Bitcoin miners do find a new block, they add it to something called a blockchain. This is a digital ledger that chronologically records cryptocurrency.
Bitcoin miners receive rewards whenever the participant places a new block on the blockchain. The reward is newly released Bitcoins, also known as a block reward. Miners also get to keep the mining fees that come with the transactions in their blocks.
As a means of preventing fraud, all Bitcoin transactions are logged and available to the public to view. This can prevent fraud, as it impedes duplication of transactions.
The Importance of Controlling Your Own Cryptocurrency Wallet
In a virtual currency system, a user creates a “wallet.” A wallet is a digital computer file that contains information to send and receive units of a virtual currency. When the wallet is created, this generates a random wallet address. This is a unique alphanumeric identifier, a concept that’s very similar to an e-mail address. The wallet has a public key and private key. The public key is essentially the public address of the wallet. Whereas the private key is only known to the wallet holder.
If you don’t have a private key, you won’t be able to access your wallet, therefore you won’t have access to cryptos inside. Now let’s look at this in reverse: if you have the private key, you control everything that’s inside of the wallet. Therefore, it’s extremely important that you keep your private key confidential so no outsider has access to your wallet. You can have multiple wallets, but only one private key. And you should think of that private key as the pin number to your debit card.
Your cryptocurrency wallet can come in multiple forms. There are:
- Digital cryptocurrency wallets
- Online cryptocurrency wallets
- Hardware cryptocurrency wallets
- Paper cryptocurrency wallets
Digital wallet
You can access your cryptocurrencies using your phone or tablet.
Online wallet
Much easier to use, you can access your private key on a computer connected to the internet. However, someone else controls your key.
Hardware wallet
Your key goes into a secure hardware device. It’s somewhat like a digital vault, and is considered one of the safest ways to hold your cryptocurrency.
Paper wallet
This is an offline wallet where your public and private key are printed together in a document. This document contains has the ability to create a number of Bitcoin private keys, which creates a “wallet of keys.” It’s a safe form of securing your crypto because it’s not on the internet and cannot be hacked.
How The IRS Treats Cryptocurrency
On March 25, 2014, the IRS (Internal Revenue Service) issued the first statement regarding their stand on cryptos in Notice 2014-21. The IRS stated:
“Virtual currency is treated as property for U.S. federal tax purposes…general tax principles that apply to property transactions apply to transactions using virtual currency.”
This means that the Internal Revenue Service treats the income and gains from the sale of cryptocurrency as an asset. That makes it subject to either short-term or long-term capital gains tax rates. Because the IRS treats cryptocurrency as an asset and not a currency, significant taxes will apply when using cryptos. The IRS also imposes record-keeping rules on the use of digital currency.
Since their 2014 notice , the IRS has not issued another statement regarding digital currency. This means that it’s still treated as an asset. If you hold digital currency for over a year, the gain will be calculated as if it’s ordinary income and tax on it decreases. Of course, if you invest in crypto using a Roth IRA, you pay no taxes.
Tax Advantages of Using a Self-Directed IRA LLC to Invest in Cryptocurrency
The IRS tax treatment of virtual currency creates a favorable tax environment for retirement account investors. In general, when a retirement account generates income or gains from the purchase and sale of a capital asset, despite whether the gain was short-term or long-term, the retirement account doesn’t pay any tax on the transaction. Additionally, any tax will be deferred to the future when the retirement account holder taxes a distribution.
Therefore, using retirement funds to invest in cryptocurrencies, such as Bitcoin, can allow the investor to defer any tax from the investment. In the case of Roth, you completely eliminate taxes. However, it’s important to note that retirement account investors who have interest in mining Bitcoin versus trading can become subject to the Unrelated Business Taxable Income (UBTI) tax rules. The UBTI tax occurs if the “mining” of cryptos is considered as a trade or business.
So, why use a Self-Directed IRA LLC to Buy Cryptocurrencies?
There are many reasons why you should use a Self-Directed IRA LLC to invest in cryptocurrency such as Bitcoin.
- Tax-free gains
- No time limit for holding property – no need to worry about 12 month holding period for long term capital gain treatment
- Potential to earn a larger rate of return on invested capital
- Diversify your retirement portfolio from over-exposure to Wall Street
- Protect your retirement funds from inflation or a falling U.S. dollar
- Invest with privacy
How to Use a Self-Directed IRA LLC to Invest in Cryptocurrency – The Wallet Control IRA
Follow these steps to use your Self-Directed IRA to make crypto investments.
- Establish a Self-Directed IRA account.
- Rollover your retirement funds (cash or in-kind – tax-free) to new Self-Directed IRA account.
- The IRA assets will then be transferred to the LLC tax-free in exchange for 100% interest in the newly established IRA LLC.
- You, as manager of the LLC, will open a bank account for the LLC at any local bank. IRA Financial Group will draft an LLC Operating Agreement identifying you as manager of the LLC and the IRA as the sole member.
- You, as manager of the LLC, will have “Checkbook Control” over all the assets/funds in the IRA LLC to make the cryptocurrency investment.
- A cryptocurrency account will be opened in the name of the IRA LLC. IRA Financial Group has helped thousands of clients establish cryptocurrency accounts for their Self-Directed IRA LLC.
- As manager of the LLC, you will then wire the IRA LLC funds to the new cryptocurrency account opened at the exchange. The account will be opened in the name of the IRA LLC. As manager of the LLC you will have the option of keeping the cryptos on an exchange, such as Coinbase, or move them to a digital or hard wallet you control and where you hold the private key.
- Since the LLC is owned 100% by an IRA, it will be treated as a disregarded entity for tax purposes. No Federal income tax return needs to be filed. All income and gains from the cryptocurrency investment will flow back to the IRA without tax.
There are many steps, but when you choose a Self-Directed IRA specialist at IRA Financial Group, establishing an IRA that you self-direct is fast and simple. If you’re ready, call today at 1-800-472-0646.
Why Do I Need to Use an LLC To Have My Self-Directed IRA Purchase Cryptocurrencies?
Generally, there are two ways to invest in cryptocurrencies with a Self-Directed IRA:
- The custodian controlled Self-Directed IRA
- The Self-Directed IRA LLC
Many people believe that investing in cryptocurrencies using a Self-Directed IRA is quite risky. This is because a third party generally holds the cryptocurrency wallet. In other words, the IRA owner does not have control over the cryptocurrency wallet. You, as the IRA owner, has no possession of the wallet private key. Additionally, each time the IRA wishes to buy or sell cryptocurrencies, they are must go through the IRA custodian or affiliated broker. This can elicit high commissions of up to 5% on each transaction.
IRA Financial Trust believes the Self-Directed IRA LLC solution is a far more secure and cost- effective platform for retirement investors. With our “Wallet Control” IRA, you will have total control over the cryptocurrencies held by the LLC. You can then open an exchange account in the name of the LLC. Therefore, you’re able to hold the coins on the exchange or on a wallet, either digitally, online, paper or hardware. Also, the IRA holder can sell the cryptos through any exchange and have more control over the fees and costs involved. The “Wallet Control” IRA gives the IRA holder total control over the cryptocurrencies, wallet, and private key, as well as offer a cost-efficient way to buy and sell the cryptocurrencies.
Conclusion
Cryptocurrency investments, such as Bitcoin, are risky and highly volatile. Any investor interested in learning more about Bitcoin should research and proceed with caution.
Before using a Self-Directed IRA to purchase cryptocurrencies, you should consult with your financial or tax advisor to make sure the investment is suitable and right for you. Give us a call at 800.472.1043 for more information!
