IRS Notice 2014-21
According to an official IRS ruling from Notice 2014-21, digital currencies are treated as personal property for taxation purposes, thus making them legally eligible to be held as assets within a Self-Directed IRA. Consequently, anyone who converts their existing retirement account to a Self-Directed IRA can allocate a portion of their savings into digital currencies with zero penalty. (Only in very rare cases are penalties possible.) Since digital currencies are treated as personal property, they receive tax-deferred status, allowing them to appreciate in value without immediate tax liability. Any profit from buying and selling digital currencies within your account can be reinvested in other retirement assets and retained tax-free until taken as a distribution.
Other Updates from the IRS on Cryptocurrencies
Since 2019, the IRS has taken an increased interest in American cryptocurrency holdings. In that same year, the IRS sent over 10,000 letters to taxpayers who had unreported crypto transactions. “At that point, the IRS said ‘We’ll let you fix this,’ but is less likely to do that moving forward,” said Knox Wimberly, an IRS enrolled agent and the CEO of Taxaroo.
Why? Because now there’s a great big question on page 1 of the IRS Form 1040:
At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?
In other words? If you have any cryptocurrencies, no matter how you received them, no matter what the specific cryptocurrencies are, the IRS wants you to tell them.
See how to buy crypto with your IRA. Get a free info guide here.
IRS: “Crypto is property, not money” (except when it isn’t)
Generally speaking, the IRS views all cryptocurrencies, from bitcoin to dogecoin, as property, not currency, for tax purposes. Now that might not sound like a big deal, but here’s why it matters: whether you sell your crypto for cash, or trade it, or even use it to buy a Tesla, that transaction becomes a taxable event. You might receive an IRS form 1099-K based on the transaction. Regardless, the IRS requires you to report it.
If you have a gain, you’ll be taxed (either at your tax bracket for a short-term gain, or 0%-20% as a long-term gain if you held your crypto over one year).
Weirdly, if you ever receive cryptocurrency as pay for work you’ve done, the IRS does treat that similarly to income. And yes there’s another form you’ll likely get, Form 1099-NEC, and yes, the IRS requires you to report crypto payments you receive in exchange for work.
See how to buy crypto with your IRA. Get a free info guide here.
Fortunately, holding cryptocurrencies in an IRA avoids many of these complications. As Investopedia says:
For those intent on investing in bitcoin, it may be possible to avoid hefty capital gains taxes by including digital currencies in certain types of retirement accounts.
Learn more about how to get a cryptocurrency IRA here.
Clarifying When to Check “Yes”
Since the IRS released its 2014 initial guidance on virtual currency (and further clarification in 2019), we can extrapolate some basic guidelines. Here’s when it might be best to check “Yes” to the virtual currency question:
- received cryptocurrency for free (including hard fork airdrop or mining)
- transacted virtual currency for goods or services
- sold cryptocurrencies for cash
- exchanged crypto for “other property” (including other types of crypto)
According to IRS guidance, the following cases do not count as a cryptocurrency transaction:
- Moving crypto between two accounts or wallets that you own
- Simply holding (not transacting) cryptocurrencies.
And the filing, oh the filing. The IRS expects you to report all cryptocurrency transactions the same as you would report another, similar activity. For example, a sale might go on Form 8949 and Schedule D.
As a public service, BitIRA collaborates with tax professionals to produce a yearly Crypto Tax Guide.