Understanding Digital Currency Mining and Airdrops: Why Preferred Trust Does Not Custody Them in Self-Directed IRAs

Digital currency, mining and airdrops have become familiar terms. However, not all financial custodians allow these activities within self-directed Individual Retirement Accounts (IRAs). At Preferred Trust, we prioritize compliance and tax efficiency, which is why we do not custody digital currency mining or airdrops in self-directed IRAs. Here’s a closer look at these activities and the reasons behind our policy.

What is Digital Currency Mining?

Digital currency mining is the process by which new coins are created and transactions are added to a blockchain. Miners use powerful computers to solve complex mathematical problems, and in return, they are rewarded with new coins. This process is essential for maintaining the blockchain’s integrity and security.

What is an Airdrop?

An airdrop in the cryptocurrency world refers to the distribution of free coins or tokens to a large number of wallet addresses. This usually happens to promote a new currency or to reward loyal users. Airdrops can also occur as a result of a hard fork, where an existing blockchain splits into two, creating a new cryptocurrency.

Hard Forks and Airdrops: Tax Implications

A hard fork is a significant change to a blockchain protocol that makes previously invalid blocks/transactions valid, or vice-versa. This creates a divergence from the old blockchain, leading to the creation of a new digital currency. A widely known example is the Bitcoin Cash hard fork from Bitcoin in 2017.

When a hard fork occurs, existing holders of the original cryptocurrency often receive the new cryptocurrency through an airdrop, typically in proportion to their existing holdings.

IRS Ruling on Hard Forks and Airdrops

The IRS addressed the tax implications of these events in IRS Rev. Rule 2019-24. This ruling clarified the following:

No Gross Income Without New Cryptocurrency: A taxpayer does not have gross income if they do not receive new cryptocurrency as a result of a hard fork.

Ordinary Income with Airdrop: If a taxpayer receives new cryptocurrency through an airdrop following a hard fork, it is considered ordinary income.

This means if you receive new cryptocurrency through an airdrop, it’s a taxable event and must be reported as ordinary income.

Why Preferred Trust Does Not Custody These Activities in Self-Directed IRAs

Tax Implications for IRAs:

You might assume that a self-directed IRA shelters your investment returns from tax consequences. Unfortunately, this is not the case with airdrops resulting from hard forks. The IRS considers the new digital currency received as ordinary income, subject to Unrelated Business Income Tax (UBIT).

Understanding UBIT:

UBIT applies to income generated from activities unrelated to the IRA's exempt purpose, which is to save for retirement. Earnings classified as ordinary income, such as those from airdrops, can be subject to UBIT, which could reach up to 37%. The IRA account owner is responsible for filing the IRS 990-T tax form to report this income.

Compliance and Risk Management:

Preferred Trust, like many other custodians, aims to ensure the highest standards of compliance in managing IRA assets. Facilitating investments that could trigger significant tax liabilities and compliance burdens for account holders is counterproductive to these standards. Thus, we do not support digital currency mining or airdrop activities within our Self-Directed IRAs.

Protecting Your Investments:

By not facilitating these activities, we help you avoid the unexpected tax consequences and administrative complexities associated with UBIT. Our priority is to safeguard your retirement assets and ensure that your investments are managed within a compliant and tax-efficient framework.

While digital currency mining and airdrops offer exciting opportunities, they come with significant tax implications, particularly for self-directed IRAs. Preferred Trust’s policy to not custody these activities is rooted in a commitment to compliance and protecting your investment’s tax-advantaged status. By understanding these nuances, you can make more informed decisions about your retirement investments and avoid potential pitfalls.

For more information on managing your Self-Directed IRA and understanding the implications of digital currency investments, please reach out to our team at Preferred Trust. We're here to help you navigate the complex landscape of retirement investing with confidence and clarity.