The Good, The Bad, and The Ugly of Digital Currency - Part 11
Updated: Oct 17, 2022
This series of articles are intended to shine a light on all the bullshit out there about digital currency investment in your self-directed IRA.
This part is just a bonus section that other custodians do not talk about, but we do because you need to know. We said there are no taxes, so why are we bringing this up? Unfortunately, we have to address the digital currency manhandlers out there. You must watch out for the forks in the road. Literally, the IRS ruled on this to set the record straight. IRS Rev. Rule 2019-24: In 2019, the IRS issued IRS Rev. Rule 2019-24 to establish tax implications for when digital currency investors participate in an “airdrop” of new digital currency derived from a “hard fork.” Below is a direct excerpt from the ruling:
A taxpayer does not have gross income under § 61 as a result of a hard fork of cyrptocurrency the taxpayer owns if the taxpayer does not receive units of a new cyrptocurrency.
A taxpayer has gross income, ordinary in character, under § 61 as a result of an airdrop of a new digital currency following a hard fork if the taxpayer receives units of new digital currency.
If you participate in digital currency investments with a Self-Directed IRA, you may be thinking that your tax advantaged account will shelter your investment returns from any tax consequences. Unfortunately, this is not an insulated event for an IRA account, and here’s why.
What is a hard fork and an airdrop? If you are not familiar with the terminology, a hard fork is when there is a permanent split in an original blockchain to create a new digital currency on a new blockchain. A widely publicized example that you can refer to is when Bitcoin hard forked to create Bitcoin Cash in 2017. There have been various others since then, but none with as much success as Bitcoin Cash. An airdrop is the delivery of the new digital currency from the hard fork to holder of the digital currency, typically in equivalent volume to their current holdings. To participate in the airdrop, the digital currency holders must be able to show proof of their current holdings.
What does the IRS ruling mean? IRS ReV. Rule 2019-24 has determined that in the event of a hard fork, if a digital currency holder participates in an airdrop to receive the new digital currency, the new currency is treated as ordinary gross income which makes this activity a taxable event. If the digital currency holder chooses not to participate in the an airdrop in the event of a hard fork, then there are no tax consequences. This income classification is extremely important to understanding the tax implications for an IRA that chooses to participate in this type of investment activity. What are the tax implications for an IRA? Unrelated Business Income Tax (UBIT), per the IRS regulations in a retirement account that receives what is determined to be ordinary income, not passive income, then those earnings will be subject to UBIT. Depending on the amount of income earned, it could be subject to up to 37% in UBIT related taxes. If UBIT applies, the IRA account owner is solely responsible for filing the IRS 990-T tax form. Can a Preferred Trust Company client participate in a hard fork or airdrop? As a licensed custodian, Preferred Trust Company reserves the right to facilitate or not facilitate certain investment activities in order to preserve the highest standard of compliance in the custody of IRA assets. For this reason, Preferred Trust Company (as have many other custodians), will not facilitate this investment activity within a client’s IRA. Is there another option for clients that still want to participate in the hard fork or airdrop with assets in their IRA? There is a method that clients can use to participate in a hard fork or airdrop to avoid subjecting their IRA to UBIT. However, we strongly encourage clients to perform their due diligence on the method and the platforms that they choose to perform the airdrop. Depending on the platform, you could be required to provide the private key to the digital currency for the platform to verify the number of units of the original digital currency held to receive the new digital currency.
Parting words… Your retirement account is made up of your hard-earned money during your glory years intended to support you in your golden years. Open your eyes and protect your money and investments against all the bullshit out there.