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6 Things to Know Now About Bitcoin, the IRS and Self-Directed IRAs

  |  By Joseph Adams

Bitcoin was back in the news last week after a big announcement from the IRS. The agency’s ruling has widespread implications for Bitcoin users, but also brings to the fore some important points about using tax-advantaged IRA accounts to invest in the cryptocurrency.

So what should investors take away from this new development? Here’s the scoop:

What did the IRS say?
The IRS announced that it considers Bitcoin to be “property” instead of “currency.” In other words, it intends to tax Bitcoin the same way it would any asset (think stocks and bonds). Users will need to track the purchase and sale price of their bitcoins and pay capital gains tax on the difference.

Is that a good thing or a bad thing?
The general consensus is that it’s a mixed bag. On the one hand, this ruling poses a challenge for people who use bitcoins to buy and sell things online, since each transaction would be considered a taxable event. And because the price of Bitcoin is very volatile, tracking the buy/sell price of any given bitcoin is sure to be a headache for the user.

However, the fact that the IRS has acknowledged Bitcoin enough to create some rules around it could signal more regulation – and widespread acceptance – to come. If so, this could be the start of Bitcoin’s transition into the mainstream.

What does this have to do with IRAs?
Now that there are hard and fast rules around the taxation of Bitcoin, many investors are wondering how to invest in a more tax-advantaged way. Self-directed IRAs have allowed people to use their retirement dollars to invest in alternative assets – including things like Bitcoin – for many years now. For example, an investor could use a self-directed Roth IRA to put post-tax dollars to work buying bitcoins, then avoid cap gains tax on any increase in price.

How can I use an IRA to invest in Bitcoin?
After establishing a self-directed IRA (for example, through a custodian like PENSCO), there are two ways to add bitcoins to your account. The first is to use an intermediary custodian such as SecondMarket’s Bitcoin Investment Trust (BIT). The second is to set up an LLC within your IRA, through which you can purchase bitcoins directly.

What do I need to know about establishing an LLC in my IRA?
There are a number of vehicles available to IRA investors that allow them a layer of asset protection, and LLCs are the most popular of those vehicles. An LLC is a legal form of business enterprise that provides limited liability to its owners. LLCs can be formed very quickly and inexpensively, and are not taxed as entities in most states.

Any other considerations?
It’s important to understand that, just like any other IRA investment, you can’t transfer bitcoins out of your account (e.g. spend them online) without incurring the associated IRS penalties and fees. For this reason, the investors who use their IRAs to invest in Bitcoin are likely interested in the capital appreciation as opposed to the online transaction capabilities. And, as always, you should make sure the risk/return profile matches with your objectives.

This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal