You've seen all the headlines. Bitcoin is huge, and not going away anytime soon. The volatility can be difficult to stomach. But if you are ready to take the plunge, it would be nice to do it in a tax efficient manner.

What if you could invest in Bitcoin and get a tax deduction? What if you could buy and sell Bitcoin without having to report taxable gains and losses each year? There could be an innovative answer for you.

The Bitcoin 401k

I imagine that you have heard of a 401k plan. In fact, you may have had one at a prior employer. But many entrepreneurs don't realize that they can have a 401k for their business...a certain kind of 401k that is.

The plan is actually called a solo 401k. The key to qualifying is that you need to be the only full time qualified employee. You cannot have any employees who work more than 1,000 hours and are age 21 or older. If your spouse is employed by the business, he or she can contribute as well.

Solo 401ks are suitable for sole proprietorships, limited liability companies (LLCs) and corporations. They work for companies in a wide range of industries. So long as you meet the requirements and have a desire to fund the account, you are set.

The great news is that the IRS allows you tremendous flexibility in what you can invest in. You are prohibited from investing in certain insurance policies, S corporation stock and collectibles. Bitcoin does not fall into any of these categories, and is therefore an allowable investment.

The true beauty of a solo 401k plan is that you can be your own trustee. Instead of having a custodian that manages your assets, you have total control. This effectively allows you to "self-direct" your investments.

Let's look at an example

Business owners are able to contribute up to $18,000 ($24,000 if age 50 or over) of earned income to their solo 401k. As employers, the business is able to contribute an additional 25 percent of employee compensation to the 401k as a profit sharing contribution.

For example, let's assume you are under the age of 50 and earned $50,000 in W-2 wages from your S corporation. You can contribute up to $18,000 to your solo 401k, and your business can contribute an additional $12,500 (25 percent of your compensation). In this case, the total maximum contribution is $30,500. Not bad.

The advantages of this strategy are that you:

  • get a full tax deduction for the $30,500;
  • can open and fund a plan by December 31st to get a tax deduction for the current year;
  • get tax deferred growth and are only taxed when funds are dispersed upon retirement;
  • are not taxed on trading gains and losses;
  • can invest the money in any asset class that is not specifically prohibited; and
  • are not required to make annual contributions if you don't want to.

How it works

How does this relate to cryptocurrency? If you contribute to your solo 401k and then make your Bitcoin investments (ideally as part of a diversified portfolio), the contribution is tax-deductible. The key is that you establish a plan, make sure you are the designated trustee, and be careful of any prohibited transactions.

I must confess that I have not invested in Bitcoin, nor would I at this price. When folks with limited financial backgrounds start piling in I get a little scared. But that's just me.

You should take the same approach when investing in Bitcoin as you would any other investment. Make sure it meets your investment criteria, check it against your investment objectives, and evaluate the risk.

I am certainly not making the case that you should use your retirement for Bitcoin. I am just trying to give you tax efficient options. Retirement planning and cryptocurrencies can co-exist. Find a strategy that works for you.

Published on: Dec 18, 2017
The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.