Buying Dogecoin with a Self-Directed IRA or Solo 401(k)
Why Use Retirement Funds to Buy Dogecoin?
There are three main reasons to consider investing in Dogecoin with your retirement funds: taxes, diversification and getting into an emerging asset class. While Dogecoin may be your primary interest, you can invest in countless Cryptos in a Self-Directed IRA.
- Using retirement funds is the smart way to invest in Dogecoin
- The top three benefits are tax treatment, diversification and investing in an emerging asset class
- Our partnerships allow you to get started quickly and affordably
Tax Benefits of Buying Dogecoin
Back in 2014, the IRS issued IRS Notice 2014-21, which classified cryptocurrencies, including Dogecoin, as property, like stocks and real estate. This subjects them to the capital gains tax regime. When you use a Self-Directed IRA or Solo 401(k) plan to invest, you don't need to worry about taxes.
When using personal funds to invest, you need to know the details of every Dogecoin transaction you make. This includes the date you bought it, how much you paid for it, the date and price when you sold it, and how long each crypto was held. At the time of sale, you will either owe short-term capital gains (held less than 12 months) or long-term capital gains (held greater than 12 months).
When you use retirement funds to invest, you don't have to worry about these details every time you transact with Dogecoin. Why? Because, retirement plans are tax-advantaged, meaning you do not pay taxes on the investments held inside of them. IRAs and 401(k) plans can either be pretax or after-tax.
Pretax or Traditional IRA or 401(k) - Traditional retirement plans are funded with pretax money, meaning you will receive an upfront tax break. You don't owe taxes on any funds you contribute to the plan each year. The taxes are deferred until you start distributing funds during retirement.
Roth IRA or 401(k) - Roth contributions are made with after-tax money. Because of this, there is no immediate tax break. The benefit of these plans comes on the back end. All qualified Roth distributions are tax free! To be qualified, you must be at least age 59 1/2 and have a Roth plan open for at least five years.
Diversification
Any financial advisor or retirement specialist will tell you that you must properly diversify your holdings. As the saying goes, don't put all your eggs in one basket. It makes good financial sense to spread across your investments, whether it be stocks, bonds and mutual funds, or alternative investments, such as real estate, precious metals, Dogecoin, and other cryptocurrencies.
If you are fully invested in the stock market and it takes a dive, guess what? So does your entire portfolio. Proper diversification allows one to ride through down periods with certain investments. For this same reason, you shouldn't put all of your money into Dogecoin. Cryptos have had a tumultuous ride since the start. Dramatic swings in the price can affect your bottom line if you are too invested.
Emerging Asset Class
Don't miss out on the latest, emerging asset class. Imagine if you can go back in time and invest in Amazon, Tesla or Microsoft when they first went public? The cryptocurrency market, including Dogecoin, is still in it's relative infancy. The Blockchain technology behind them is improving all the time, so why not take a chance?
Of course, investing in Dogecoin is not for everyone. There is an inherit risk in new asset types, especially something that not everyone is in favor of. It's up to you, as the investor, to decide if the risk is worth the reward. Working with a financial advisor is your best bet before deciding whether or not to make a particular investment. Of course, it's important that you do your own due diligence before investing in any emerging asset class.
Read More: Crypto IRAs and Private Keys
Self-Directed IRA or Solo 401(k) for Dogecoin?
You've decided you want to invest in Dogecoin, so what plan should you choose? A lot depends on the type of income you earn. Are you self-employed or do you work for someone else? If you are self-employed, it's a no-brainer; the Solo 401(k) is the best plan for you. For everyone else, a Self-Directed IRA is the way to go.
Solo 401(k)
In order to utilize the Solo 401(k) plan, you must have some kind of self-employment income. This can be from your own business, contract work or gig jobs, among other things. The second requirement is that you have no full-time employees, other than a spouse or business partner. The Solo 401(k) is arguably the best plan for the self-employed and features a number of benefits.
The Solo 401(k) plan offers high annual contributions limits, the ability to borrow up to $50,000, a Roth option, UBTI exemption and limitless investment opportunities. So long as your investment is not a collectible and does not involve a disqualified person, you can probably make it. This, of course, includes investing in cryptos, including Dogecoin.
Self-Directed IRA
Anyone with earned income can open and fund a Self-Directed IRA. In fact, if you already have a retirement plan, you can generally roll those funds into a Self-Directed IRA. Although it is not as feature-rich as the Solo 401(k), there are no restrictions for who can open one.
When you choose the right custodian, such as IRA Financial, you can invest in almost anything, including Dogecoin, with your retirement funds. A Self-Directed IRA can either be pretax (traditional) or after-tax (Roth). A traditional plan allows for upfront tax deductions since taxes are deferred until you withdraw from the plan. There is no immediate tax break with a Roth IRA, however, all distributions are tax free, assuming you are at least age 59 1/2 and any Roth IRA has been open for at least five years.
Why Choose Dogecoin?
As you may know, Dogecoin started out as a joke, based on the popular "Doge" meme, featuring a Shiba Inu with some text. Since its inception, it was barely worth a fraction of a penny. Of course, as with many things, it became popular for a couple of reasons. Redditors were the first to jump on the train, followed by Tesla founder, Elon Musk. Dogecoin topped out at about 72 cents in early May, 2021 before settling down about half that price.
Obviously, it's a way cheaper alternative to other cryptos, especially the "big dog," Bitcoin, which sits at over $50,000 per token. Dogecoin describes itself as "an open source peer-to-peer digital currency, favored by Shiba Inus worldwide." Obviously, tongue-in-cheek that doesn't take itself too seriously. It sits just shy of 50 billion market cap. It's become quite popular for "microtipping" and for unique fundraising campaigns. While it may not see the success of other cryptos, it's a fun, and cheap, way to get into the crypto space.
Real Estate UBTI - When Does it Apply?
What is UBTI?
UBTI is defined as “gross income derived by any organization from any unrelated trade or business regularly carried on by it” reduced by deductions directly connected with the business. An exempt organization that is a limited partner, member of an LLC, or member of another non-corporate entity will have attributed to it the UBTI of the enterprise as if it were the direct recipient of its share of the entity’s income which would be UBTI had it carried on the business of the entity.
Related: What is the UBTI Tax Rate?
Debt-Financed Property
UBTI also applies to unrelated debt-financed income (UDFI). “Debt-financed property” refers to borrowing money to purchase real estate (i.e., a leveraged asset that is held to produce income). In such cases, only the income attributable to the financed portion of the property is taxed; the gain on the profit from the sale of the leveraged assets is also UDFI (unless the debt is paid off more than 12 months before the property is sold).
There are some important exceptions from UBTI: those exclusions relate to the central importance of investment in real estate – dividends, interest, annuities, royalties, most rentals from real estate, and gains/losses from the sale of real estate. However, rental income generated from real estate that is “debt-financed” loses the exclusion, and that portion of the income becomes subject to UBTI. Thus, if the IRA borrows money to finance the purchase of real estate, the portion of the rental income attributable to that debt will be taxable as UBTI.
Related: UBTI and Real Estate Investing
Regularly Carried on Business
For an IRA, any business regularly carried on or by a partnership or LLC of which it is a member is an unrelated business. For example, the operation of a shoe factory, the operation of a gas station, or the operation of a computer rental business by an LLC or partnership owned by the Self-Directed IRA LLC would likely be treated as an unrelated business and subject to UBTI.
Although there is little formal guidance on UBTI implications for self-directed real estate IRAs, there is a great deal of guidance on UBTI implications for real estate transactions by tax-exempt entities. In general, Gains and losses on dispositions of property (including casualties and other involuntary dispositions) are excluded from UBTI unless the property is inventory or property held primarily for sale to customers in the ordinary course of an unrelated trade or business. This exclusion covers gains and losses on dispositions of property used in an unrelated trade or business, as long as the property was not held for sale to customers.
In addition, subject to a number of conditions, if an exempt organization acquires real property or mortgages held by a financial institution in conservatorship or receivership, gains on dispositions of the property are excluded from UBTI, even if the property is held for sale to customers in the ordinary course of business. The purpose of the provision seems to be to allow an exempt organization to acquire a package of assets of an insolvent financial institution with the assurance that parts of the package can be sold off without risk of the re-sales tainting the organization as a dealer and thus subjecting gains on re-sales to the UBIT.
Learn More: UBIT and House Flipping
IRA Unrelated Business Taxable Income Rules
When it comes to using a Self-Directed IRA to make investments, most investments are exempt from federal income tax. This is because an IRA (individual retirement account) is exempt from tax pursuant to Internal Revenue Code 408 and Section 512. However, you should be aware of the UBTI rules.
The Internal Revenue Codes exempt most forms of investment income an IRA generates from taxation. Some examples of exempt income include:
- Interest from loans
- Dividends
- Annuities
- Royalties
- Most rentals from real estate
- Gains/losses from the sale of real estate
However, the IRS set forth rules in the 1950s to prevent charities, and later IRAs, from engaging in an active trade or business. Charities and IRAs had an unfair advantage due to their tax-exempt status.
IRA investors can find the UBIT rules under Internal Revenue Code Sections 511-514. These rules are classified as the Unrelated Business Taxable Income rules.
If you trigger the UBIT rules, the income you generate from activities will generally be subject to close to a 40% tax for 2019. Note – an IRA investing in an active trade or business using a C Corporation will not trigger the UBIT tax.
Real Estate Investments & UBTI
In Mauldin v. Comr. 195 F.2d 714 (10th Cir. 1952), the court explained that there is no fixed formula or rule of thumb for determining whether property sold by a taxpayer was held by him primarily for sale to customers in the ordinary course of his trade or business. Each case must rest upon its own facts. The court identified a number of helpful factors to point the way, among which are the purposes for which the property was acquired, whether for sale or investment; and continuity and frequency of sales as opposed to isolated transactions. However, in Adam v. Comr. 60 T.C. 996 (1973), acq., 1974-1 C.B. 1., the Tax Court analyzed the following factors in determining whether the taxpayer was engaged in the operation of a trade or business, which determine if the Real Estate UBTI rules come into play:
1. The purpose for which the asset was acquired: Examples of good facts that support the conclusion that the sale of the property is excluded from unrelated business taxable income is when the property was originally acquired to further the organization's tax-exempt purpose – in the case of an IRA – investment.
2. The frequency, continuity, and size of the sales: This Real Estate UBTI factor is particularly significant in determining whether the sale constitutes a trade or business that is regularly carried on, within the meaning of Internal Revenue Code Section 512. It may range from a one-time sale of a parcel of land to many sales over a long period. If sales are infrequent, not continuous, and small, the organization will not likely be viewed as similar to a taxpayer in the trade or business of selling real estate. Conversely, as sales become more frequent, more continuous, and larger, they are more likely to be considered a trade or business that is regularly carried on, comparable to the commercial activity of a taxpayer in the trade or business of selling real estate.
However, in PLR 9247038, the IRS issued a favorable ruling to an organization that planned to sell land in up to 15 sales spread over a five- to 10-year period. The reason for the number of sales over time was that the value of the land was such that it was unlikely a single purchaser would be able to acquire the entire parcel. Also, market conditions dictated this sales process for the organization to receive maximum value and keep control of the pace and type of development that would occur after the sales. Similarly, in PLR 9017058, where the exempt organization was engaged in selling 45 of 68 lots, such sales were deemed to meet the exception from unrelated business income under Internal Revenue Code Section 512(b)(5). Although this quantity of sales is admittedly significant, external forces dictated the high number of sales. The organization first tried to sell the property in one block but was unsuccessful due to the inflated cost of developing the property to comply with local ordinances. According to the IRS, had these two facts been absent, i.e., (1) the organization had attempted to sell the entire property, and (2) local ordinances required certain development prior to the sale as residential property, it is possible that the high number of sales, in this case, would have resulted in unrelated business taxable income.
Thus, a limited number of sales is usually a “good fact” for purposes of the facts and circumstances test. However, one should not assume that a set limit applies such as, for example, 15 sales. Rather, one should remember that factors such as the frequency of sales and cost of the property to be sold, and market conditions play a part in the number of sales allowed and the period of the sales allowed. If an organization has significant amounts of acreage, or the cost of the property precludes finding one purchaser, then it is more likely that the organization will be permitted to sell the property in more than one transaction, and still comply with the requirements of Internal Revenue Code Section 512(b)(5).
3. The activities of the seller in the improvement and disposition of the property: The smaller the extent of improvements by the organization to the property, the more likely the sale will fall under the exclusion for unrelated business income under Internal Revenue Code Section 512(b)(5). In PLR 8043052, an organization proposed to sell a parcel of undeveloped raw land. The fact that the land had remained undeveloped was significant in determining that gains from the proposed transaction would not constitute unrelated business taxable income. In PLR 8522042, the property in question consisted of both developed and undeveloped lands. The developed lands included residential land improved with single-family dwellings or condominium apartments. However, all the improvements were constructed by unrelated third parties. The absence of development activity by the organization demonstrated that it was not holding property for sale to customers in the ordinary course of trade or business.
4. The extent of improvements made to the property: The more minimal the activities of the owner in improving and disposing of property, the more likely its sale will meet the exclusion from unrelated business taxable income under Internal Revenue Code Section 512(b)(5). Of course, the greater the number of improvements allowed, the greater the likelihood of maximizing gain from the sale. So, there is a balancing act that organizations must exercise when preparing land for disposition to maximize its return, while not acting too much like a dealer and triggering Real Estate UBTI.
The IRS ruled favorably on improvements made to the property in accordance with city or local ordinances requiring the organization to construct a street as well as curb, gutter, sidewalk, drainage, and water supply improvements in order to subdivide the property for sale.
Retaining limited control of the redevelopment project before the land is eventually sold also has been an acceptable activity by a tax-exempt organization when the organization is not involved in any way with advertising, marketing, or otherwise attempting to sell the lots. In PLR 200544021, an organization-maintained control over the development process to ensure a compatible environment for the adjoining high school. The IRS recognizes that even though an organization is concerned with receiving a high yield from the sale, it may be equally concerned that the property be developed in keeping with the surrounding features of the property. In addition, an organization's interest in preserving the natural beauty of a tract of land to be developed is not generally indicative of a normal sales transaction.
Not All Solo 401(k) Plans Are The Same
In PLR 8950072, a tax-exempt foundation's largest asset was a parcel of unimproved real estate. The foundation was examining four ways of using the property: (1) continue leasing the property; (2) sell the property as is; (3) complete some preliminary development work — obtaining permits and approvals — and sell the property; or (4) completely develop the property before sale. The last alternative would provide the highest return. The IRS ruled that the first three alternatives would not subject the foundation to UBIT or adversely affect its exempt status. However, the last alternative, to assume all the responsibilities of development, would result in UBTI, but would not affect the foundation's exempt status. Alternative 4 is very similar to the situation in Brown v. Comr. In that case, the taxpayer intended to subdivide and develop the property for sale to the public. Such sales would not be isolated or casual transactions. The organization planned to be extensively involved in both development and marketing activities. Thus, the IRS concluded that the property will be held primarily for sale to customers in the ordinary course of trade or business and not subject to the exclusion from unrelated business income of Internal Revenue Code Section 512(b)(5).
Aside from development activities, the lack of marketing of the property by the organization helps differentiate it from a taxpayer in the trade or business of selling real estate. For example, in PLR 8522042, an organization's lack of promotional or development activity in connection with the proposed sale demonstrated that it was not holding property for sale to customers in the ordinary course of a trade or business. Moreover, the use of real estate brokers or other independent contractors is not determinative. Rather, the pertinent facts involve the extent of the activities of the organizations themselves in promoting and marketing the property.
5. The proximity of sale to purchase: In evaluating this factor, generally the longer the period between purchase and sale, the more likely the sale will be excluded from Real Estate UBTI. For example, in PLR 9505020, the fact that a school received land by bequest and held it for a significant period was considered a favorable factor, and the IRS did not impose Real Estate UBTI on the sale of the land when the school was facing condemnation proceedings and it did not actively advertise the sale.
6. The purpose for which the property was held during the taxable year: In evaluating this factor, the longer the period between purchase and sale, the more likely the sale will be excluded from UBTI. For example, in PLR 9505020, the fact that a school received land by bequest and held it for a significant period was considered a favorable factor, and the IRS did not impose UBTI on the sale of the land when the school was facing condemnation proceedings and it did not actively advertise the sale.
In Adam and subsequent cases, the Tax Court found that no single factor is controlling but all are relevant facts to consider in determining whether the sale of property occurred in the regular course of the taxpayer's business. In numerous private letter rulings, the IRS cites and applies these same Adam factors. The IRS has characterized these factors as a “facts and circumstances test.” The IRS has even applied these same factors when analyzing the activities of an exempt organization that are carried out through a limited partnership between the exempt organization and the developer.