Paying taxes on crypto is a major hassle, requiring you to report every trade, purchase, sale, or exchange to the IRS. The good news is there’s an easy way to invest in crypto tax-free. And you don’t have to renounce your citizenship, start a business in Puerto Rico, or open an offshore life insurance policy.
It’s called a crypto IRA, and it works like any traditional or Roth IRA, providing you a tax-advantaged or tax-free method for investing in virtual currencies like Bitcoin, Ethereum, or Solana.
In this post, we’ll:
- Discuss how to avoid paying crypto taxes with an IRA
- Review the basics of cryptocurrency taxes
- Weigh the pros and cons of crypto in an IRA
How to Avoid Taxes on Cryptocurrency with an IRA
By investing in cryptocurrency with an IRA, you can take advantage of the tax benefits traditionally associated with retirement accounts.
Like 401(k) or 403(b) accounts, IRAs are retirement investment accounts that offer special tax advantages—if you wait until age 59 ½ to make a withdrawal or qualify for an early withdrawal exception.
While we’ll be focusing on the two most common, be aware that there are four types of IRAs:
- Self-employed pension (SEP)
- Savings incentive match plan for employees (SIMPLE)
It is worth noting, however, that SEP and SIMPLE IRAs work the same as traditional IRAs, only with higher yearly contribution limits and different rules around income.
How to Invest in Crypto Tax-Free with a Roth Crypto IRA
Roth IRAs have been attracting a lot of media attention lately. While these reports have prompted questions about wealthy investors using Roth IRAs as tax shelters of sorts, companies like Alto are helping ordinary investors realize the true potential of these retirement plans.
Why are so many wealthy investors housing massive investments within Roth IRAs? Unlike traditional IRAs, which we’ll discuss in a moment, investments in Roth IRAs are not tax deductible.
Instead, they offer a potentially greater benefit: Roth IRAs allow your investment to grow completely tax-free, so long as you wait until six months after turning 59 to make your first withdrawal and you’ve had a Roth account for at least five years. Not to mention, there is no requirement to begin taking minimum distributions at age 72, as with other IRAs.
When it comes to crypto, this is huge. No matter how many times you sell or trade crypto, or how much your investments grow, you won’t pay a dime in taxes—either in capital gains or when you go to withdraw. Even if you had invested $1,000 in Bitcoin in 2011—the equivalent of around $3 million today—had you done so within a Roth IRA, you would owe nothing in taxes.
So with tax-free withdrawals, why would anyone invest in a traditional IRA?
Roth IRA Contribution Limits
When Congress created Roth IRAs, they were aware that tax-free withdrawals could be abused, so they placed income caps on contributors. And while it is possible to roll over another IRA, 401(k), or 403(b) by way of what is called a backdoor Roth IRA, you can’t actively contribute if your income is over a certain level. You’ll also need to pay a one-time tax.
In 2021, individuals whose modified adjusted gross income (MAGI) is $140,000 or more (and couples whose MAGI is $208,000 or more) are ineligible to contribute to a Roth IRA.
How to Invest in Crypto Tax-Advantaged with a Traditional Crypto IRA
Just because traditional IRAs don’t offer tax-free withdrawals doesn’t mean you won’t benefit from investing in Bitcoin through a traditional crypto IRA. It could work out to your advantage.
If you currently have a larger income than you anticipate during retirement, you may benefit from tax-deductible investing up front and paying income tax on your distributions. That’s because you may be in a lower tax bracket at the time of withdrawal.
Not only that, contributions to a traditional IRA are tax-deductible. That means you can write off up to $6,000 a year—$7,000 a year if you’re 50 or older. In other words: Tax-deductible crypto investing.
Now that we’ve covered how to avoid taxes on Bitcoin and other altcoins, a quick recap of cryptocurrency taxes is in order.
What You Need to Know About Crypto and Taxes
Crypto tax laws themselves aren’t actually that complicated.
Like other assets—such as gold, stocks, or bonds—the IRS classifies crypto as property. As a result, you don’t pay taxes on Bitcoin until you sell or trade it. (Keep in mind that this also applies to using profits from investing in crypto to purchase non-crypto items.)
Reporting crypto earnings on your taxes, on the other hand, can be confusing and time-consuming. For starters, you’ll need to fill out several tax forms—including the 1040, Form Schedule D, and Form 8949, to name a few. This includes reporting every sale or trade, the amount you originally paid, the sale price, and the date of the sale.
And while many crypto exchanges allow you to download transaction records as an Excel or CSV file, some only provide your transactions for the last month or quarter—if at all.
Whatever the case, the burden is on you to correctly report each and every taxable event. This includes:
- Sales of crypto
- Trades for other coins
- Exchanges for USD or other currencies
- Purchases using crypto
Additionally, if you are participating in decentralized finance (DeFi) yield farming or staking and earn tokens as a result, your earnings are subject to taxation as income.
Determining Capital Gains vs. Capital Losses
Because the taxable value of property is based on capital gains or losses, you only pay taxes on cryptocurrency if you see a capital gain or other income event. These include staking rewards, yield farming, and air drops. In the event of a capital loss, individual filers can deduct up to $3,000 from their taxable income, depending on things like income and tax rate.
To calculate a capital gain or loss on a sale of crypto, subtract the price you paid (the tax basis) from the amount you sold it for.
Let’s say you bought a single Bitcoin for $4,000 in early 2019 and sold it for $34,000 in 2020. In this case, you would have owed the IRS taxes on the $30,000 capital gain.
The same applies to trades. Because in this case, you’re essentially cashing in on the value of one coin to put it toward another.
Short-Term vs. Long-Term Cryptocurrency Capital Gains Tax
Time is also a factor when it comes to crypto and capital gains taxes, as it determines what tax rate you will pay. If you sell Bitcoin for a profit within a year of purchase, it’s considered a short-term gain. However, if you wait more than a year before selling, it’s considered a long-term gain.
Predictably, the tax rate differs between long-term and short-term capital gains for crypto taxes:
- Short-term capital gains are taxed as part of your regular income. Depending on which of the seven income brackets you fall under, you’ll pay between 10% and 37%.
- Long-term capital gains taxes are not considered part of your normal income. As a result, you typically pay lower tax rates than you’d pay for short-term capital gains: Either 0%, 15%, or 20%, with most people paying either no tax or 15% tax on long-term gains.
Clearly, there’s a tax advantage to HODLing. But what if you could avoid paying taxes on crypto altogether? Or at the very least, pay less in taxes while letting your potential returns compound over time by reinvesting?
Enter the crypto IRA.
Pros & Cons of Crypto in an IRA
As a recap, if you’ve been wondering “How do I avoid paying taxes on Bitcoin?” a traditional or Roth crypto IRA may be the best way for you to invest in digital assets. However, each situation is unique. Here, we weigh the pros and cons.
Crypto IRA Pros:
- Investments in crypto via a traditional IRA are tax-deductible.
- You’ll only pay income taxes upon withdrawing from a traditional IRA—which, depending on your income at the time of withdrawal, could mean a lower tax rate than had you paid a capital gains tax.*
- You’ll never pay any taxes—capital gains or income—with a Roth IRA.*
- Reporting IRAs on your taxes is quick and easy compared to reporting crypto gains. All you have to report are your IRA contributions, and your custodian will also help with tax reporting.
- You can roll 401(k) or other IRA investments into a CryptoIRA account, allowing you to exceed the yearly IRA contribution limit.
Crypto IRA Cons:
- Until recently, with products like Alto CryptoIRA®, investing in crypto through an IRA was accessible only to the savviest of investors—and usually required a sizable investment.
- You can’t “cash out” your crypto investments before turning 59 1/2 without paying an early withdrawal tax penalty.
- You can’t move current, non-IRA crypto investments into an IRA.
- Yearly IRA investment contributions are capped at:
- You can’t write off capital losses within a cryptocurrency IRA.
*Assuming you wait until 59 ½ years of age or meet the requirement for an early withdrawal exception. Additionally, you must have a Roth IRA account for at least five years before making a withdrawal.
Discover a Better Way to Invest in Crypto
Whether you’re new to crypto and intimidated by the tax filing requirements or an experienced trader looking for a more tax-efficient way to invest, a crypto IRA could be the smartest way to invest.
Alto CryptoIRA gives you access to 175+ coins and tokens with 24/7 real-time trading, $10 investment minimums, low 1% trading fees, and no monthly account fees. Plus, all the tax advantages of an individual retirement account.