Penalities for a prohibited transaction can be severe. The IRS can distribute your entire IRA for taxation or fine your Solo 401(k) 15% of its value.
What are some examples of prohibited transactions related to cryptocurrency?
If the IRS sees fit, remember that a prohibited transaction could mean the distribution of your IRA. This means you could lose all your tax benefits for the ENTIRE IRA (not just what was invested in cryptocurrency) plus early withdrawal penalties if you are before 59 and 1/2. Solo 401(k)s can have a 15% penalty.
- Investing in an NFT, which is a collectible. The IRS does not allow collectibles in a retirement account and has always harshly disallowed art investments. Although NFT technology is new, the asset will almost certainly be banned and cause prohibited transactions when under IRS enforcement review according to past precedent, which is where an investor must look when then there is no IRS guidance on a crypto asset.
- Flowing your new IRA LLC dollars into an existing centralized exchange personal account; where you then purchased new cryptocurrency coins that were stored on behalf of the existing personal (non-retirement) account. This would ‘co-mingle’ the personal, taxable assets, and the tax-advantaged retirement, which is impermissible. It is imperative that any provider you work with correctly title the assets in the name of the IRA LLC or your Solo 401(k) Trust.
- Contributing Crypto directly into a retirement account as an IRS prohibited transaction. This crypto is personal property and must be sold, all IRS contributions must be made in fiat, and then you can purchase cryptocurrency. You cannot sell personal assets between yourself and your IRA There is no current tax-compliant mechanism to get cryptocurrency straight into an IRA and will remain that way unless the IRS reconsiders the classification of digital assets as property. All contributions you make to the IRS must be properly categorized so that you could back them up during an audit.
- Using personal wallets or storage devices to store, move, or transact retirement crypto. All devices must be purchased with the IRA. In such a new legal area, it is not wise to partition a physical device that holds both personal crypto and retirement crypto that could provide any evidence that the crypto is commingled. The IRS has expanded regulations on investors that abuse or hide assets in their home, out of the reach of anyone to verify that the asset is owned by your IRA. Read more here.
- Getting a loan to your IRA and it not being non-recourse. ALL loans to an IRA must be non-recourse according to IRAs rules. This means that in a crisis where you could not pay back your loan, the only asset that could be taken is the crypto itself. Be aware Getting a loan to an IRA could mean UBIT taxes.
- Investing cryptocurrency or directly into a company in which you own over 50%.
- A transaction with your children, grandparents, or yourself with crypto and your IRA.
- Taking cryptocurrency out of your IRA and using it outside of your IRA on personal costs, expenses, or trades.
- Any transaction the IRS could prove "was not at arm's length" and violated one of the prohibited transaction rules.