The growing popularity of cryptocurrencies has resulted in many investors adding them to their retirement portfolio. A crypto individual retirement account (IRA) offers investors several benefits, but also carries risks.
It’s important for investors to assess the tax implications of investing in a crypto IRA, and how it compares to Traditional, Roth, and SEP IRAs. Investors may be eligible for tax advantages if contributing to a specific crypto IRA, but it’s necessary to know how to utilize them.
BitcoinIRA details the key information to know about crypto IRA taxes to optimize the experience and strive for a comfortable retirement.
How Crypto Taxes Work
Cryptocurrencies are classified as digital assets. The IRS treats cryptocurrency similar to other growth assets such as stocks, property, and bonds. Digital asset gains are taxable, and you may need to report certain transactions on your tax return.
Taxable crypto transactions include the sale of digital assets, receipt of digital assets as payment for goods or services, and exchange of digital assets for property, goods, and services.
The IRS uses several factors to determine your tax rate:
- Income earned
- Tax filing status
- Period of asset ownership before disposal
Crypto IRA Tax Implications
Cryptocurrency held in an IRA isn’t subject to capital gains tax; however, the specific tax implications depend on the type of IRA you own. Using an IRA to invest in crypto has short-term and long-term implications. Some IRAs offer tax deductions on contributions, but not on distributions taken at retirement age. Other IRAs don’t provide a tax break on contributions, but distributions are typically tax-free.
Traditional IRA contributions use pre-tax income, and may be deductible the year you make them. The tax is deferred, meaning you receive upfront tax relief, but distributions at retirement age are taxed. Deductions are limited if you or your spouse are covered by a workplace retirement plan, or your income exceeds specific levels.
Your IRA contribution amounts are limited. In 2023, the yearly contribution for Traditional IRAs and Roth IRAs combined cannot exceed $6,500. Individuals older than 50 years have an annual limit of $7,500.
Investors who prefer to be taxed on their retirement contributions can opt for a cryptocurrency Roth IRA. The advantage of using this retirement option is that investors are taxed for retirement while earning an income. Distributions taken at retirement age are typically tax and penalty-free, enabling individuals to receive the full amount withdrawn.
You’re not required to report Roth IRA contributions on your tax return. Your IRA custodian will report these contributions to the IRS on Form 5498 and you will receive a copy this Form for your records. The same contribution limits apply to Roth IRA accounts as Traditional IRAs.
Investors who believe they’re going to be in a higher tax bracket in retirement tend to prefer Roth IRAs. Even if Bitcoin’s value were to rise exponentially, Roth IRA investors would not owe taxes because the account is funded with after-tax dollars.
A Simplified Employee Pension Plan (SEP) enables business owners to contribute to both an employee’s retirement account and their own retirement savings. For employees to participate in a SEP IRA, they must be at least 21 years old, have worked for the employer at least three of the last five years, and have received a minimum compensation of $750 for the year 2023.
The main advantage of a SEP IRA is that the annual contribution limits are higher than Traditional and Roth IRAs. Self-employed individuals can contribute up to 25% of annual net earnings or up to $66,000 for 2023.
A nondeductible IRA is funded with after-tax dollars. Although you can’t deduct contributions from your income tax, they grow tax-free. Contributions that produce returns or dividends aren’t taxed if they remain in your account.
As mentioned, the key difference between contributing to a nondeductible IRA and a Traditional IRA is that you cannot deduct contributions; regardless, income limits are applicable to Roth and Traditional IRAs. However, the tax benefits available to individuals contributing to a Traditional IRA aren’t available with a nondeductible IRA.
The annual contribution limit for a nondeductible account is $6,500 in 2023 for individuals under 50 years old, and $7,500 for those 50 and older.
A self-directed IRA usually offers the same tax benefits as a Traditional or Roth IRA, and has the same contribution limits. However, it’s viewed as an alternative investment account, enabling investors greater asset diversification.
The account holder manages the account, enabling the addition of assets commonly not permitted by most custodians in an IRA, such as cryptocurrencies. A self-directed IRA is available as a Traditional or Roth IRA account, through providers such as BitcoinIRA.
How to Obtain Crypto Tax Deductions
Investors not using retirement accounts can use several strategies to qualify for crypto tax deductions. The easiest way is to own your crypto investment for at least a year before selling it. After that period, you qualify for a long-term capital gains rate.
You can lower your tax rate by strategically lowering your salary, though this is understandably a less popular approach. You could also sell assets at a loss, then realize losses to offset capital gains.
Benefit from Investing in Crypto with an IRA
Investors wanting to diversify their retirement portfolio can add crypto to it. It’s important that investors assess the different IRA tax implications to determine the most suitable one for their investment goals.
Contributions to a Traditional Crypto IRA can be tax deductible, and investors can use several strategies to optimize their returns and tax advantages.
Frequently Asked Questions
Are crypto investments tax deductible?
Contributions to a Traditional Crypto IRA can be tax deductible. Whether investors are taxed on the contributions or the distributions depends on the type of crypto IRA account they choose.
How do I report crypto on my taxes?
Individuals need to report their income from cryptocurrencies as well as gains and losses. This is made simple when investing in a crypto IRA – see our guide.
How do you save on crypto taxes?
When it comes to retirement savings, use of a crypto IRA allows investors to contribute without penalties or taxes using after-tax dollars, or use pre-tax dollars for tax-deductible contributions, and only owe at retirement age.