How to Setup a Self-Directed Traditional or Roth IRA For Cryptotoken Investments

For United States citizens, or other peoples in the jurisdiction of the US who are required to pay US taxes, the laws regarding cryptotoken investments, mining, etc. can be confusing and seemingly contradictory depending on which federal agency you are listening to for guidance.

As of now, I know of no company that is a custodian of IRA funds and allows the owner of an IRA to directly buy cryptotokens with monies in the aforementioned IRA. Certain requirements would have to be met per the IRS rules regarding IRA funds. The most notable one would be the inability to move cryptotokens out of your IRA account to hold in your own offline wallet for safe storage. Other restrictions regarding distributions and transferring assets to a new IRA custodian would also have to be followed.

However, the tax-free status of earnings made from investments in a Roth IRA are highly desirable for US citizens. Fortunately, the IRS allows IRAs to directly invest in any business of the owner's (or owners' in the case of a joint IRA) choosing as long as certain conditions are met. These boil down to essentially avoiding any type of 'prohibited transaction.'

The IRS defines a prohibited transaction with a Self-Directed IRA in IRC 4975.

A general rule of thumb for prohibited transactions is to not conduct any transactions with the owner of the IRA (you), the spouse of the owner, or anyone in direct lineal descent (ancestors or descendants) of the owner. From now on, I will call these people 'prohibited persons.'

An IRA cannot invest in a business if the business is held in combination by more than 50% of those who are prohibited persons.

In addition, prohibited persons may not receive compensation for services rendered to the LLC nor may the LLC receive services from a prohibited person for free that will benefit the LLC.

In order to invest IRA funds into various blockchain technologies, one must first find an IRA custodian that allows for a direct investment into an incorporated business. More than likely, the best option would be an LLC, as this is a pass-through entity for tax purposes. What this means is that any taxes that would need to be made by the LLC are made by the owner of the LLC, which happens to be the IRA, and, as we have established, the IRA does not pay taxes. The IRA custodian is required to report to the IRS certain information about the IRA each year.

However, most IRA custodians do not allow for direct investments into LLCs. Custodians who provides these niche services are few and far between, and often require you to pay (exorbitant amounts, in my opinion) for them to incorporate the LLC, write the operating agreement, and obtain a Federal EIN. You can, however, be persistent and do all this yourself and not pay for the additional services that these IRA custodians offer. Be aware that you perform these tasks at your own risk.

Once you have found an IRA custodian that does allow for self-directed investments (I suggest Madison Trust), have created the LLC, and obtained a Federal EIN, you must then setup a bank account for your LLC.

After this task is complete, you direct your IRA custodian to invest your IRA funds into the LLC by depositing money into the LLC's bank account (normally through some official-looking form). You can then buy (and sell) cryptotokens as you normally would and (actively) watch your investment grow tax-free.

Internal Revenue Service Circular 230 Disclosure: In compliance with IRS requirements, you are on notice that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Disclaimer: I am not a tax advisor. This article is not intended to be construed as advice. Talk with a tax professional to find out if this is the right course of action for you.