In this 3-part educational series, we’ll discuss bitcoin and other cryptoassets, including background on the exciting new asset class, how your Solo 401k plan can hold crypto compliantly, and the tax advantages of using your Roth Solo 401k plan to grow your gains tax-free.
Part II of our series discusses holding bitcoin and other cryptocurrencies inside your Solo 401k plan.
Can your retirement account own crypto?
Yes! Cryptocurrency and other crypto assets are allowed inside of the retirement accounts just like gold, real estate, stocks, bonds and ETFs.
IRS Thoughts on Cryptocurrencies
The IRS released notice 2014-21 on March 25, 2014 where they state they don’t exactly treat cryptocurrencies like currency, but rather more like property (real estate). This sparked a long debate between the Securities and Exchange Commission (SEC) and the Commodities & Futures Trading Commission (CFTC) on whose domain crypto assets fall.
In notice 2014-21, the IRS states, “virtual currency is treated as property for U.S. federal tax purposes” which also means any profits made on selling those currencies result in “general tax principles that apply to property transactions apply to transactions using virtual currency”.
To put it plainly, the IRS will charge capital gains taxes on any profits made by selling crypto assets, either short-term capital gains (treated as ordinary income) or long-term capital gains (generally 15-20% if the asset is held longer than twelve months).
IRS Perspective: Crypto assets in your 401k
The IRS doesn’t tell you what you (or your retirement account) can invest in. Much like the Ten Commandments, the IRS prefers to tell you what is prohibited.
Both section 408 and section 4975 of the Internal Revenue Code (IRC) detail what types of investments and what type of persons are prohibited from transacting with the retirement account.
Prohibited Transaction rules are designed so that neither the participant nor the retirement account can benefit from the other’s involvement. In other words, you can’t have a sweetheart deal for yourself or the retirement account. The Department of Labor and IRS have decided the easiest way to keep that from happening is to prohibit certain “disqualified persons” from transacting with the retirement account.
A disqualified person is defined in IRC Section 4975(e)2 and generally includes:
- The 401k plan participant (you)
- Your spouse
- Your parents and grandparents
- Your children and grandchildren
- Business or entity you (or your spouse) own or have a controlling interest
- Business or entity your parents own or have a controlling interest
- Business or entity your children own or have a controlling interest
Since the IRS considers crypto assets to be a capital asset, similar to real estate or stocks/bonds, the retirement account is allowed to buy, sell and hold crypto!
Steps to Using the Solo 401k to invest in Crypto
Crypto assets are purchased from a cryptocurrency exchange. These exchanges are highly regulated as they are the “onramp” from fiat currency (e.g. dollars, pounds, yen, etc) to crypto assets.
You can open a crypto exchange account in the name of your Solo 401k trust or through a Special Purpose LLC.
The crypto exchanges Gemini, Kraken, and Bittrex will allow you to open a crypto exchange account in the name of your 401k trust.
For all other exchanges, you’ll open an account in the name of the Special Purpose LLC connected to your Solo 401k. This structure is often called a 401k LLC, similar to the IRA LLC structure (Checkbook Control IRA).
Let’s go over the steps to getting crypto assets in your Solo 401k:
- Set up and fund the Solo 401k with Nabers Group, the industry leader
- The Nabers Group team will prepare all the Solo 401k plan and trust paperwork, including your Adoption Agreent, Basic Plan document, Trust agreement, beneficiary designation forms, IRS opinion letter (proving the legitimacy of your Solo 401k plan), in-plan Roth conversion forms, Required Minimum Distribution formst, etc.
- The Nabers Group team will get a brand new tax ID number for your 401k trust. All transactions you do with our 401k funds should use the 401k trust as the entity, using the new trust tax ID number we’ll obtain
- We’ll help you rollover funds into the new Solo 410k so you get money into your control faster
- We’ll also help you open a bank account for you to receive rollover and/or contribution funds. Because of our impeccable reputation in the industry, we have negotiated lower (or no) bank fees for Nabers Group clients.
- Open an exchange account to buy crypto assets
- The crypto echange account will be in the name of your 401k trust, or us the Special Purpose LLC (more info below). This should be a brand new exchange account. You cannot use a pre-existing crypto exchange account. No personal funds are allowed in this new crypto exchange account, retirement assets only.
Optional: Crypto-Specific LLC
One optional step some Solo 401k accountholders take, which is to form a crypto-specific LLC.
Our team can form the LLC for you, or you can do it on your own (or with the help of an attorney). Some states are more favorable than others. We like Wyoming for their low fees and respect for member and manager privacy.
The new LLC must be Special Purpose LLC (not a general purpose LLC as with a business). The LLC must be brand new (you can’t use an LLC you formed previously). The reason is because the member of the LLC should be your 401k trust, and you are the manager.
The Special Purpose LLC will use distinct type of Operating Agreement designed to work with Solo 401k plans. The Nabers Group team can help prepare this for you.
After your Special-Purpose LLC has been formed, you’ll want to invest your Solo 401k funds into your new LLC.
This step is only included if you plan to invest in crypto asset through your 401k LLC. Write the check from your Solo 401k trust bank account to the new Special Purpose LLC bank account.
Complete Investment authorization form provided by Nabers Group for your records.
Helpful Hints on Buying & Storing Crypto in the Solo 401k
- Use cold storage (offline hardware wallets): This reduces your exposure to hacking on cryptocurrency exchanges
- Open a brand new exchange account in name of 401k plan (or special purpose LLC. Do not use an existing exchange account you opened in your name for retirement account holdings
- Only use retirement funds from your Solo 401k, or 401k LLC for your retirement funds exchange account
- Never mix personal holdings with retirement holdings (online or offline)
- As your own 401k plan administrator, keep good records of what you purchased and when
- Never share your exchange login information, or your private keys with anyone
- Always buy crypto from reputable exchanges (you are not allowed to buy or sell crypto to or from any disqualified persons)
Stay tuned for Part III of our Crypto Education Series:
Grow Your Gains Tax-Free With Roth 401k
Do you have questions about bitcoin? Have you purchased crypto personally? Let us know your questions and thoughts in the comments below!