Many of my clients want to hold Bitcoin in an IRA or 401(k). However, most of the “Bitcoin IRA” companies out there (BitcoinIRA, Kingdom Trust, BitGo, Regal Assets, etc.) charge large custodial fees for doing so.
Wouldn’t it be great to avoid all these issues by just holding cryptocurrency directly, in control of your own private keys, while still maintaining the tax benefits of an IRA or Roth IRA? This would allow you to cut out all of those middleman fees.
It turns out there is a way to do this, so long as you know how to avoid the hidden traps.
Quick note: All references to an “IRA” in this article refer not just to traditional IRAs, but also to Roth IRAs. The strategies in this article are also available for 401(k)s, as discussed later.
When you hold funds in an IRA (or Roth IRA), under the Internal Revenue Code, the default rule is that the funds may not be held by you directly. They must instead be held by a custodian for your benefit. The custodian is typically your bank or brokerage. The first issue when holding Bitcoin in a retirement account, then, is that most custodians will not allow Bitcoin to be held in their accounts. Further, even if you were comfortable with the high fees of the few custodians who do allow Bitcoin holdings, using their services would mean having a third party in control of the private keys, which is sub-optimal from a security standpoint.
The good news is that in three simple steps, you can open your own “Bitcoin IRA”, cutting out all of the middlemen and their ongoing fees. And if you don’t want to handle these steps yourself, contact us and we can do the entire process for you. This might be a good idea, because if you attempt this on your own, even the slightest mistake immediately makes your entire IRA subject to tax.
Step 1: A Checkbook IRA
The first step is to form a “checkbook entity” for your IRA. This entity can be an LLC, or more often nowadays, an unincorporated investment trust. The checkbook entity is 100% owned by your IRA. You personally are appointed trustee of the entity if it is a trust, or manager of the entity if it is an LLC. As trustee or manager, you have free reign to invest the entity’s funds as you wish, without custodian approval.
This setup requires: a relationship with an IRS-licensed IRA account provider, proper formation of the entity, and a special trust agreement or operating agreement for the entity designed not to violate the IRA prohibited transaction rules. If you engage us to handle the process for you, we can square away all of these items for you.
Whenever funds enter your IRA, they immediately drop down into the checkbook entity where you have full control over them.
(Special Note for Californians: Your state has an outrageous $800/year fee on LLCs. The good news is that this fee is easily avoided by using an unincorporated investment trust rather than an LLC as the checkbook entity. Contact us for details.)
While checkbook IRA entities are allowed under IRS rules, they don’t obviate the “prohibited transaction rules” of IRC 4975. IRC 4975 outright bans IRAs (including checkbook entities owned by IRAs) from investing in certain classes of assets. The good news is that Bitcoin is not one of those classes. In fact, the IRS considers Bitcoin to be property rather than currency, making it an investment similar to real estate, stocks, or bonds for tax purposes.
(Note: We can set up an IRA-owned checkbook entity for you. Click here to get started.)
Even after you have your IRA-owned checkbook entity set up, the prohibited transaction rules present unique obstacles to holding Bitcoin directly, as described below.
Step 2: Loading the IRA Checkbook Entity
The first obstacle is purchasing Bitcoin at a reasonable exchange rate in the name of the entity, rather than in your personal name. It’s very important to note that a transfer of Bitcoin from you to your IRA (or IRA checkbook entity) is a prohibited transaction. This is because “cryptocurrency” is considered property for tax purposes, and IRA contributions must be made in US Dollars. So it is key to first transfer US Dollars into the IRA, which will then flow into the checkbook entity’s checking account. From the entity’s checking account, Bitcoin can be purchased.
To do this, you will need to open an account on a cryptocurrency exchange. Unfortunately, many exchanges do not allow accounts in the name of an entity. Examples of exchanges which do allow entity “institutional” accounts are Paxos, Gemini, Swan Bitcoin, River Financial, Kraken, and for larger purchases in select states, Unchained Capital OTC. Customer service may tell you that it’s easier to simply set up your exchange account in your own name and attach your entity bank account, but again, to be extra safe regarding the prohibited transaction rules, I don’t suggest this. Be sure to open a full “institutional” account in the name of your checkbook entity.
I would also suggest sticking to US-based exchanges, as using a foreign exchange would create a requirement of FBAR reporting.
If you are able to use a decentralized exchange, that would be another option. Unlike a “regular” exchange, decentralized exchanges do not register an “account” in anyone’s name, so they eliminate the obstacle of getting an account titled to a checkbook entity. Decentralized exchanges are very new, however, and aren’t yet accessible to most people. For this reason, most will stick to the traditional cryptocurrency exchanges.
Opening an institutional account can be tricky. Note: The good news is that if you engage our firm to set up your checkbook IRA, we’ll take you through the whole process and make it easy. Click here to get started.
Step 3: Getting an IRA Checkbook Entity Wallet
Your next obstacle is deciding on a wallet for holding your Bitcoin. If your Bitcoin holdings are very small, you may choose to leave them in your exchange trading account (although this is not typically recommended). Instead, you may wish to transfer them to an external wallet for security. It is VERY important that “ownership” of the wallet must vest in the checkbook entity, not you personally. This is because any exchange of assets between you and your IRA (or your IRA checkbook entity) is a “prohibited transaction” under IRC 4975(c)(1).
If your holdings are substantial, for your own safety you may want to use collaborative custody multi-signature solution with geographically isolated keys. There are companies that can help coordinate this for you, such as Unchained Capital (available in all 50 states).
If you choose to set up your own non-custodial multi-signature or single signature wallet storage, be sure that any hardware wallets (or other private keys) used in your checkbook entity setup are used only in your checkbook entity setup, and not for any other non-IRA funds.
A quick note about 401(k)s: In this article, I discuss holding Bitcoin in an IRA. However, if you have a self-directed 401(k) (a type of plan typically only available to a self-employed business owner), the process works much the same. In fact, it is slightly easier. Unlike IRAs, self-directed 401(k)s do not require a third party custodian. A 401(k) does have a trustee, but typically the business owner will be trustee of his own plan. This means that as trustee, you can invest 401(k) funds in Bitcoin using the steps above directly, rather than having to set up a checkbook entity intermediary. You will need a prototype plan sponsor to provide 401(k) documents preapproved by the IRS. If you need help setting up a self-directed 401(k) for your business, click here.
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Disclaimer: Information provided is for educational purposes only. Nothing herein constitutes legal advice or investment advice. Readers are responsible for their own due diligence in selection of investments, exchanges, and technology platforms.