A crypto IRA allows the account holder to invest in a retirement account using cryptocurrency. Like any type of IRA, the account will be subject to certain tax regulations and advantages.
However, it’s important to consider how the Internal Revenue Service (IRS) classifies cryptocurrency, as this determines how it is taxed.
The IRS classifies cryptocurrency as personal property, which means capital gains tax applies to crypto invested in an IRA. With traditional crypto IRAs, this tax applies to any value increase once the funds are accessed. This does not apply to Roth crypto IRAs, which are funded with taxed money.
In this article, we’re going to break down everything you need to know about crypto IRA accounts and tax rules. We’ll be explaining the tax benefits associated with different crypto IRA accounts, how the IRS classifies virtual currencies, and which account type is the best for investing in cryptocurrencies.
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Do Crypto IRA Accounts Have Tax Benefits?
One of the major drawing points for IRA accounts is the associated tax benefits they offer the account holder. When it comes down to crypto IRA accounts, how your account is taxed ultimately depends on your type of crypto IRA.
There are two main types of crypto IRA accounts.
The first type is known as a traditional Crypto IRA. With this type of account, your annual contributions can be deducted from your taxable income. The amount you’re permitted to contribute in a given year will depend on your income and filing status.
In many ways, traditional crypto IRA accounts operate in the same way as traditional IRA accounts. Another similarity is that a penalty and tax liability will apply to funds withdrawn before the account holder reaches the age of retirement.
With a traditional crypto IRA, you will be subject to immediate tax benefits by way of deductions. However, you’re ultimately deferring the payment of taxes to the point at which you start withdrawing funds from your account.
However, there are also Roth crypto IRA accounts. With this type of retirement account, you will also save using cryptocurrencies. With a Roth IRA, you will not be able to deduct your annual contribution from your taxable income.
However, any interest earned with this type of account will not be subject to capital gains tax.
Furthermore, once the holder of a Roth crypto IRA account reaches the age of retirement, there will be no tax charged on distributions. Taxes are paid as contributions are made into this type of IRA.
This type of crypto IRA offers better tax benefits down the line. Any interest earned on your cryptocurrency will be exempt from capital gains tax.
From the above, it is clear that cryptocurrency-based IRA accounts are also tax-advantaged like any other IRA investment. However, the manner in which these crypto IRA accounts are taxed and when tax benefits are received differ.
Ultimately, how your crypto IRA is taxed and when you benefit from the relevant tax laws will be determined by the account you choose to open.
How Does The IRS Classify Cryptocurrency?
To open a crypto IRA account, you’ll need to use a certified trading platform. Luckily, there are many platforms for you to choose from. The trading platform you use needs to meet all the relevant regulations as stipulated by the IRS. This will allow you to receive tax advantages from your account.
Regardless of which type of crypto IRA account you open, it’s important to understand how the Internal Revenue Service (IRS) classifies cryptocurrency. It’s imperative to take note of this, as it will highlight certain limitations of these retirement accounts.
In the previous section, we discussed the fact that Roth crypto IRA accounts are exempt from capital gains tax on any interest earned on contributions. This is due to the fact that tax is paid as contributions are made to the account.
However, there’s an important clue here as to how cryptocurrency is classified by the IRS.
Essentially, capital gains tax is a levy that is paid on the profit of the sale of certain assets. This type of tax typically applies to the sale of real estate, property, precious metals, and stocks.
With the rise of cryptocurrency, the IRS now classifies cryptocurrencies as personal property. Due to this, capital gains tax applies to cryptocurrency.
When you purchase cryptocurrency personally, it will either be subject to short- or long-term capital gains tax. Short-term capital gains tax rates will apply to assets that are sold after being held for a year or less.
For assets that are held for longer than one-year, long-term capital gains tax applies, which generally has a lower tax rate.
However, any cryptocurrency that is bought personally cannot be sold to your IRA. However, as we’ve established, it is possible to invest in cryptocurrency through means of a crypto IRA account.
As a result of the IRS’s classification of cryptocurrency as personal property, capital gains tax will apply to cryptocurrency invested in IRA accounts.
With a traditional crypto IRA, you will eventually have to pay capital gains tax on any interest earned once you begin accessing your funds. Of course, you’ll be able to deduct contributions from your table income.
One drawback of this is uncertainty about future capital gains tax rates.
With a Roth crypto IRA, your account will be funded through money that has already been taxed. By paying taxes as contributions are made, you will be exempt from paying capital gains tax on any increase in contribution values.
Furthermore, Roth crypto IRA account holders will be eligible for a tax-free income when they retire.
Which Crypto IRA Account Offers The Best Tax Benefits?
With any type of IRA account, the tax benefits are one of the most appealing aspects. However, as we have established thus far, these benefits differ between different crypto IRA account types.
Due to this, you may be wondering which account type offers the best tax benefits when investing with cryptocurrency.
On the one hand, the upfront tax benefits offered by a traditional crypto IRA are appealing. However, so is the fact that Roth crypto IRA accounts are exempt from capital gains tax on any interest that is accrued by investments.
Ultimately, a Roth crypto IRA is the best type of account for a long-term solution to investing in cryptocurrency.
In fact, due to the way cryptocurrencies are classified by the IRS, many consumers realize it’s better to invest in cryptocurrencies through an IRA as opposed to using their personal standpoint.
In the previous section, we outlined how cryptocurrencies purchased with personal funds are subject to capital gains tax.
When considered from a tax standpoint, the best way to invest in cryptocurrency is through a Roth crypto IRA. With this type of IRA, you’ll be able to mitigate future capital gains tax rates.
With many investors hoping to see a significant increase in many cryptocurrency values, this positions you perfectly for a bigger payoff down the line.
Is Crypto in Your IRA Worth It?
In terms of functionality, there are many similarities between regular IRA accounts and cryptocurrency-based ones. However, due to the IRS’s classification of cryptocurrencies as personal property, capital gains tax applies to crypto IRA accounts.
Like other IRA accounts, crypto IRA accounts provide tax advantages.
However, the manner in which your account is taxed and when you benefit will depend on your type of account. When investing in cryptocurrencies, a Roth crypto IRA account is often preferred.
This type of IRA prevents account holders from paying capital gains tax once they access their retirement fund.