How To Save On Bitcoin Taxes Using An IRA
Many investors believe that bitcoin and the technology behind it, blockchain, will reshape the global financial markets. Even though the cryptocurrency market is still in its infancy, demand is growing from investors who wish to buy into an emerging asset class. Accordingly, since bitcoin is still not widely used as a form of digital money for consumption purposes, from an investment standpoint, its main benefit is as a long-term investment into a future asset category. (Full disclosure: Author owns bitcoin and other cryptocurrencies in a retirement account.)
Bitcoin, created in 2009, is the first and most popular type of digital currency, also known as cryptocurrency. The most exciting part of bitcoin is the decentralized blockchain technology behind it. As far as cryptocurrencies are concerned, the blockchain is essentially a digital ledger of all transactions of a coin. The blockchain prevents double-spending of a coin, which is essentially counterfeiting a currency. The belief is blockchain can help the global economy become more efficient, secure and transparent.
In late October, bitcoin surpassed $13,000, and its price has been above $10,000 since late July. However, although bitcoin is considerably up for the year, the total market capitalization for the entire cryptocurrency industry is less than the amount of cash on Apple’s balance sheet, according to a September report from Cointelegraph.
Bitcoin As An Investment
For many bitcoin investors, it’s all about the future. These investors are holding the cryptocurrency as a long-term investment. The general belief of proponents is the price of bitcoin will rise dramatically in the future based on the principles of scarcity, divisibility, utility and transferability. Therefore, the opportunity to hold bitcoin in an account that can allow the asset’s long-term growth to be sheltered from federal income tax has been growing in popularity.
Tax Treatment Of Owning Bitcoin Personally
IRS Notice 2014-21 made it clear that bitcoin is to be treated as property, like a stock, for tax purposes. Hence, any gains and losses from the sale of bitcoin and any other cryptocurrency would be subject to capital gains tax. When it comes to determining the amount of capital gains or losses from a transaction involving a capital asset, such as bitcoin, two important tax principles must be addressed: basis and holding period.
Basis is the price paid for an asset. If one bitcoin was purchased for $1,000, then that is the basis for that one “coin.” If, at a future date, another coin is purchased for $1,500, that is the basis for that coin.
The holding period is crucial for determining the tax rate that will be paid on any capital gains transaction. In general, a capital asset held less than 12 months is deemed a short-term capital gain and is subject to ordinary income tax rates. The top marginal federal tax rate on ordinary income in 2020 is 37%. A capital asset that is held greater than 12 months is treated as a long-term capital gain and subject to the reduced long-term capital gains rate of 15%, or 20% for high-net-worth individuals. Therefore, the basis of a particular cryptocurrency and the length of time it was held determines the type of tax that is paid.
In the case of a capital loss, other than $3,000 of capital losses that can annually be used to offset ordinary income, short- and long-term capital losses must be used first to offset gains of the same category. However, if the losses of one type exceed the gains of the same type, then one can apply the excess losses to the other type.
Owning Bitcoin In A Roth IRA
Since cryptocurrencies are treated as property, a retirement account, such as an IRA, may invest in bitcoin. A Roth IRA is an after-tax account, meaning it is funded with money that has already been taxed. Therefore, there is no upfront tax break afforded from a pretax, or traditional, IRA. However, assuming the Roth IRA has been open for at least five years and the IRA holder is over the age of 59 ½, all distributions are tax-free.
For people looking to invest in bitcoin long-term, using a Roth IRA to buy bitcoin instead of personal savings makes sense from a tax standpoint. Further, there’s no need to worry about basis and holding periods annually, which is a bonus for those who perform numerous crypto transactions in a year.
With hopes that bitcoin will grow in value significantly in the next 15 to 20 years, and with uncertainty surrounding the future of capital gains tax rates, a Roth IRA may make sense for long-term investors of bitcoin and other cryptocurrencies.
Taking A Cautious Approach
Obviously, the volatility of bitcoin is quite high. New investors should be aware of the risks of using retirement funds to invest in cryptos. While there is risk with any investment, the gains and losses seen by bitcoin are dramatic. It should be a long-term investment approach, and investors should be cautious if they are interested in generating current cash flow. It’s important not to put all your eggs in one basket — something that can be said about any investment.
Further, cryptocurrencies are not regulated on a federal level yet, but you can expect that to change in the coming years. How this will change the crypto universe, especially bitcoin, is unknown.
Moreover, there are sophisticated criminals looking to scam you out of your money. In fact, from January through May, fraudulent cryptocurrency-related schemes totaled $1.4 billion. It’s imperative you do your research before making any type of crypto-related investment. Lastly, you need to make sure your bitcoin or other cryptocurrency is held securely. Although the technology behind it is very secure, there are still ways for thieves to get to your funds if you are not careful.
This article originally appeared on forbes.com To read the full article and see the images, click here.
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