Can You Avoid Taxes by Investing in a Bitcoin IRA? Bitcoin is increasingly viewed as a retirement option, given its outstanding returns in the past decade.
The potential profit scenario of investing in Bitcoin in the long term comes with concern about taxes. Today, we’re exploring more about Bitcoin and crypto in retirement products (for example, IRAs and Roth IRAs), their advantages, risks, and potential tax implications.
Should I put my retirement in Bitcoin?
Bitcoin has been voted the best performing asset of the past decade, as investors interested in retirement look to it as one alternative in a diversified portfolio. However, you have several products to consider for a long-term investment strategy in crypto. Some offer benefits more than tax benefits, such as lower fees, security, or flexibility.
The first and easiest, for tax purposes, is to invest directly in Bitcoin with a long-term holding period (>1 year) and enjoy a long-term capital gains tax rate, effectively avoiding the higher amount of taxes when making a profit. The long-term tax benefits of holding cryptocurrencies exist in many other countries around the world (for example, Germany).
In addition to long-term holding, you now have the option to invest in a commonly used investment vehicle that gives you indirect exposure to bitcoin through a bitcoin futures ETF, which offers lower fees than the funds (for example, Grayscale BTC). Exchange-traded funds (ETFs) provide simplicity to traditional investors while still offering a new asset class.
Finally, investors can consider retirement accounts such as 401(k), traditional IRAs, and Roth IRAs, which now offer the option to include Bitcoin as an investment asset in your account. There are Bitcoin IRAs, Unchained IRAs, and many other options on the market that serve this need, with clear tax advantages.
Let’s see how a Bitcoin IRA or Roth IRA can help you reduce taxes.
Could Bitcoin be in an IRA?
In short, yes.
There are several ways you can invest in Bitcoin as part of an IRA. In an IRA, you can make total annual contributions, get a tax deduction, and pay taxes only when you withdraw your IRA assets.
At the time of withdrawal, you will be liable for income taxes at a tax rate according to the level of taxable income.
There are income limits for making an IRA contribution, depending on your enrollment status and whether you and/or your spouse contribute to an employer-sponsored retirement plan. Also, there is a contribution limit for IRAs each year. This year, the IRA contribution limit is $6,000, or $7,000 if you are 50 or older.
With a Bitcoin IRA, you can avoid taxes while investing, but you have to pay them when you withdraw.
Can I buy Bitcoin in a Roth IRA?
Yes. You can buy Bitcoin within a Roth IRA the same way you would invest Bitcoin in a traditional IRA. The difference between a Roth IRA and a traditional IRA is the tax benefits, annual contributions, and limits.
In 2021, you can invest up to $6,000 in a Roth IRA or $7,000 if you are 50 or older. These are the same limits found in a traditional IRA account, but the main difference comes from the tax benefits and income limits. With a Bitcoin Roth IRA, you can’t get annual tax deductions from your contributions, but you’ll enjoy tax-free benefits when you withdraw.
You can effectively avoid paying taxes by investing in Bitcoin through a Roth IRA.
Can I buy Bitcoin with a self-directed IRA?
Yes. A self directed IRA can be a traditional IRA or a Roth IRA, and as mentioned above, you can invest in Bitcoin in any of these vehicles. Contributions, tax benefits, and limits will vary depending on the choice of retirement-based investment vehicle.
Is Bitcoin IRA tax exempt?
No. With a Bitcoin IRA, you can get tax deductions based on your annual contributions, but you won’t get any tax benefits when you withdraw money. However, it is still a great way to enjoy annual tax cuts and tax-deferred growth on your crypto investment. This is a clear advantage of investing in Bitcoin in an IRA rather than directly holding Bitcoin as there are no discounting opportunities like these.
Are Bitcoin IRAs Tax Deductible?
When you invest in a Bitcoin IRA or a Roth IRA, you can face transaction fees, maintenance fees, or setup fees.
Setup fees paid to a third party to set up your self-directed IRA are not deductible. Account maintenance fees and transaction fees paid with your IRA funds aren’t tax deductible either. However, they can be used to reduce your IRA earnings which will eventually be taxable when you withdraw your IRA assets, except for a Roth IRA, which is not taxable.
Do I have to report my Bitcoin IRA for my taxes?
You do not need to report transactions in your Bitcoin IRA accounts. However, you will need to report the withdrawal of your IRA assets and pay income taxes on the withdrawals (except for eligible Roth IRA distributions). If you withdraw your IRA assets early, you may also be subject to an early withdrawal penalty.
How to Avoid Paying Taxes on Bitcoin?
Other than retirement accounts, there are other ways to legally avoid or reduce your bitcoin tax payments. The first is to hold bitcoin for the long term, and enjoy the tax rate of interest in different countries.
Second, you can donate to a charitable organization and receive a deduction from the charitable contribution, effectively offsetting capital gains and saving your taxes. If you have big capital gains but also big unrealized losses on trades that you think you won’t recover from, you can try crypto tax harvesting. This strategy is to sell one of your unprofitable trades and offset significant capital gains from your operations, saving on capital gains taxes.
More drastic measures include moving between states in the US to more crypto-friendly locations with no income tax, or states with incentives for crypto investors and businesses. Check out the best tax-friendly crypto countries in the US. You can also move to a more Bitcoin friendly country like Portugal, Malta or Puerto Rico. See our guide to the best tax-friendly crypto countries for more information.
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This can be particularly useful in gray area matters such as taxes related to asset encapsulation, liquidity pools, cropping, and others where tax guidance is still emerging.
Clarify all crypto tax questions:
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NFT Guide 2021 (with taxes).
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This post is part of the Crypto Taxes AMA series. Follow the weekly AMAs on Twitter as our expert CPA Sharon Yip answers your crypto tax questions. You can download 30+ AMA Crypto Tax Report for free.
Disclaimer: All information provided above is for informational purposes only and should not be considered professional, legal or tax advice. You should do your own research or consult with a professional financial advisor when investing.