How to Setup a Self-Directed Traditional or Roth IRA For Cryptotoken Investments
For United States citizens, or other peoples in the jurisdiction of the US who are required to pay US taxes, the laws regarding cryptotoken investments, mining, etc. can be confusing and seemingly contradictory depending on which federal agency you are listening to for guidance.
As of now, I know of no company that is a custodian of IRA funds and allows the owner of an IRA to directly buy cryptotokens with monies in the aforementioned IRA. Certain requirements would have to be met per the IRS rules regarding IRA funds. The most notable one would be the inability to move cryptotokens out of your IRA account to hold in your own offline wallet for safe storage. Other restrictions regarding distributions and transferring assets to a new IRA custodian would also have to be followed.
However, the tax-free status of earnings made from investments in a Roth IRA are highly desirable for US citizens. Fortunately, the IRS allows IRAs to directly invest in any business of the owner's (or owners' in the case of a joint IRA) choosing as long as certain conditions are met. These boil down to essentially avoiding any type of 'prohibited transaction.'
The IRS defines a prohibited transaction with a Self-Directed IRA in IRC 4975.
A general rule of thumb for prohibited transactions is to not conduct any transactions with the owner of the IRA (you), the spouse of the owner, or anyone in direct lineal descent (ancestors or descendants) of the owner. From now on, I will call these people 'prohibited persons.'
An IRA cannot invest in a business if the business is held in combination by more than 50% of those who are prohibited persons.
In addition, prohibited persons may not receive compensation for services rendered to the LLC nor may the LLC receive services from a prohibited person for free that will benefit the LLC.
In order to invest IRA funds into various blockchain technologies, one must first find an IRA custodian that allows for a direct investment into an incorporated business. More than likely, the best option would be an LLC, as this is a pass-through entity for tax purposes. What this means is that any taxes that would need to be made by the LLC are made by the owner of the LLC, which happens to be the IRA, and, as we have established, the IRA does not pay taxes. The IRA custodian is required to report to the IRS certain information about the IRA each year.
However, most IRA custodians do not allow for direct investments into LLCs. Custodians who provides these niche services are few and far between, and often require you to pay (exorbitant amounts, in my opinion) for them to incorporate the LLC, write the operating agreement, and obtain a Federal EIN. You can, however, be persistent and do all this yourself and not pay for the additional services that these IRA custodians offer. Be aware that you perform these tasks at your own risk.
Once you have found an IRA custodian that does allow for self-directed investments (I suggest Madison Trust), have created the LLC, and obtained a Federal EIN, you must then setup a bank account for your LLC.
After this task is complete, you direct your IRA custodian to invest your IRA funds into the LLC by depositing money into the LLC's bank account (normally through some official-looking form). You can then buy (and sell) cryptotokens as you normally would and (actively) watch your investment grow tax-free.
Internal Revenue Service Circular 230 Disclosure: In compliance with IRS requirements, you are on notice that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
Disclaimer: I am not a tax advisor. This article is not intended to be construed as advice. Talk with a tax professional to find out if this is the right course of action for you.
If you put your assets into an IRA and they go up dramatically in value then you can't easily get them out without having to pay the taxes right? So the taxes are only deferred until you try to take it out unless you intend to take it out in your 60s but this world will be dramatically different if you're talking about 20 or 30 years from today.
There are two different types of IRAs: Traditional and Roth. With the traditional IRA, the taxes on income are deferred. With the Roth IRA, there are no taxes on income.
You are right in that you cannot withdraw funds from your IRA without paying a penalty tax, if you do so before your retirement age. In this way, the funds are not tangible.
However, if you assume that the current power structure is not going away anytime soon, or will at least still be around in 20 to 30 years, and you want to invest in cryptotokens and reap the rewards tax free without engaging in tax evasion, then this is a decent solution. In addition, if you expect a collapse of the USA, the complete devaluation of the dollar, etc., then having assets in cryptotokens in an IRA LLC allows you to have fungibility (in terms of having control of the private keys, approving transfers, etc.) is one way to protect yourself if / when this occurs.
There are other, more ingenius, ways to make the funds immediately tangible. This would require structuring an LLC that is not owned by more than 50% by prohibited persons. In this case, your IRA could own a portion of the LLC (say 49%), and you could legitimately be paid by the LLC for the services you render to it. Obviously, these payments would be taxable income at this point.
The other 51% could be owned by siblings, sibling-in-laws, nieces, nephews, aunts, uncles, friends, or any other entity.
Doesn't look like a good option: https://www.pensco.com/blog/dont-pay-yourself-a-salary-out-of-your-ira-llc-heres-why/
Yes. You don't pay yourself a salary from a company that is owned by prohibited persons if the total control / stock of the company of their combined stake is more than 50%.
Didn't I say that in my comment ;).
Also, you'll note that the article you linked to is an example where the IRA LLC owns more than 50% of the company in question when the IRS took them to court.
Your comment only gives an example of people not following the rules, being caught, and subsequently prosecuted.
I don't think what you're saying really applies here ...
There are caveats to legally pull funds out of a Roth IRA prior to age 59 1/ 2 and avoid the 10% penalty: here are some specific ones - medical, disability, being a first time homebuyer, taking distributions as an annuity, taking contributions after a 5 yr waiting period
Good info. I just assume not take it out before 59 1/2.
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This is very useful and I like the clear instructions. I always liked the idea of using Self-directed IRAs and they are perfect for cryptoinvestments. There are some contribution and income limits for IRAs/Roth IRAs here, but generally speaking you can invest up to $5,500 or $6,500 (if over 50) in a tax-deferred account. Roth IRAs are also good for estate planning since you don't have required minimum distributions (RMD) as with Traditional IRAs. The only downside with Roth IRAs is you use after-tax contributions. Hence one of the factors that may influence someone to use a Roth or Traditional IRA is what a person believes his/her tax rate will be now compared to the future. It's advantageous to use a Roth if someone is in a lower tax bracket now compared to the future.
....or someone can just use stealth transactions.
Disclaimer: I am also not a tax advisor. This article is not intended to be construed as advice. Talk with a tax professional to find out if this is the right course of action for you.
I find the tax-free advantages of the Roth IRA to greatly outweigh the tax deferment that the Traditional IRA offers. This is simply due to the fact that I find taxation to be nothing more than legalized theft. If the US Congress wants to create laws that allow me to not pay taxes, I will gladly follow those rules and reap the rewards.
I agree with your sentiments about taxes in general. Roth IRAs have good additional benefits, esp if tax rates are lower now than retirement, but you use after-tax dollars for Roth contributions (traditional IRAs let you deduct contributions) so to compare a Roth to a Traditional you can compare tax rates now vs. the future.
This roth IRA knowledge is vital to this community. Just Translated this and Tweeted it. Thanks!
Self-directed IRA is becoming more and more interesting. I wouldn't mind rolling mine over into one w/ a mix of some traditional stuff with a mix of metals, crypto and real estate. and who knows maybe other stuff. I have little faith in USD, bonds and stocks in the next year.