By Jim Glass, JD
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Bitcoin is receiving a surge of publicity as a possible IRA investment, and a number of new firms have recently started targeting the "Bitcoin IRA" market. Here are six things to know about investing IRA funds in Bitcoin:
1) There is no such thing as a "Bitcoin IRA." Although the term is often seen in the media and advertising, there is no such thing any more than there are "stock market IRAs." Legally, a "Bitcoin IRA" is simply an IRA like any other, except that its custodian permits investments in Bitcoin.
2) Bitcoin is not an "IRS Approved" investment. This claim is frequently made in advertising, but the IRS does not approve investments. In fact, the IRS has issued a notice specifically to IRA owners headlined "The IRS Does Not Approve IRA Investments" and warning against what it calls the "Fraudulent 'IRA Approved' Sales Pitch."
IRAs can invest in Bitcoin simply because they are allowed to invest in almost anything except collectibles and life insurance. When the term "IRS Approved" misleadingly implies some sort of endorsement, it may cast doubt on the bona fides of the party making the claim. The IRS warns: "Avoid any investment touted as 'IRA Approved' or otherwise endorsed by the IRS."
3) Although created as a cyber currency for use in payment transactions, the IRS taxes Bitcoin as property. This means that every sale of Bitcoin results in a capital gain or loss, either short term or long term. This, of course, creates recordkeeping challenges, especially for persons who use Bitcoin frequently in purchase and sale transactions. Tax reporting requires that they keep basis records for their Bitcoin acquisitions and calculate capital gain or loss on Bitcoin dispositions.
Investing in Bitcoin through an IRA simplifies matters by eliminating this capital gain accounting. Distributions from a Roth IRA can qualify to be tax free, while those from a traditional IRA are taxable at ordinary income tax rates.
On the other hand, Bitcoin in an IRA can't be used to make purchases of items put to personal use; gains on Bitcoin held in a traditional IRA will be taxed at ordinary income rates when distributed, losing the tax-favored long-term capital gain tax rate.
4) Bitcoin investments receive no government guarantees and are vulnerable to theft and hacking. Bitcoin is like physical currency: it has to be stored somewhere. If it is lost or stolen the owner is very unlikely to get it back. This makes Bitcoin a target of theft.
In 2014 ,the largest Bitcoin exchange in the world, Mt. Gox, collapsed after the loss of 850,000 Bitcoin, then worth $450 million. It is possible to secure Bitcoin on one's own computer, but that can be lost or stolen too. Steve Wozniak, co-founder of Apple, recently reported being scammed out of $70,000 of Bitcoin. The U.S. Commodity Futures Trading Commission has issued a consumer advisory detailing the risks of trading Bitcoin and other virtual currencies.
5) Few IRA custodians allow investment in Bitcoin and those that do are generally expensive. The vast majority of IRA funds are invested in marketable securities through major brokerage firms, banks, and other investment firms. These firms generally do not permit investment in Bitcoin. To invest in Bitcoin, one needs to have a self-directed IRA with a custodian that permits a far broader range of investments.
There is nothing new about this but these custodians typically charge significantly higher fees. The owner of a self-directed IRA may have much more personal responsibility in actively managing an IRA investment, such as real estate, than would be the case in simply selecting an investment in securities at a broker. For an investment in Bitcoin, the owner would have to manage transactions on an exchange and find a way to secure the Bitcoin investment.
What is new is that a small but growing number of firms are now offering to act as custodians for self-directed IRAs, while providing specialized services for Bitcoin investors, facilitating transactions and security. However, these generally charge comparatively high fees too, so review costs before acting.
6) Bitcoin is extremely volatile and faces growing competition. Bitcoin has surged up in value from $1 in February 2011 to $10,699 on February 27, 2018 - an extraordinary gain that no doubt explains the surge in interest in it as a retirement investment.
But it is also a very volatile investment. It has dropped in value by at least 10% in one day more than 38 times since 2012, compared to only once for the stock market in the last 60 years. Over the seven weeks from December 15, 2017 to February 5, 2018, it plunged from $17,900 to $6,200, including losing a third of its value on a single day. Today's price of Bitcoin looks great for persons who bought it early - but not so good for persons who bought it at over $17,000 a few weeks ago.
Bitcoin's past appreciation does not guarantee future appreciation, and it is now facing increasing competition from a growing number of new cyber currencies entering the market.
IRA Safety: Before investing in Bitcoin through one of the new "specialist" custodians offering Bitcoin services, be sure the custodial agreement allows you to easily shift your funds out of Bitcoin into other investments when the need arises.