Taxpayers can receive significant tax benefits when donating cryptocurrency and other appreciated digital assets to a charity. This article looks at some key considerations to keep in mind as you consider all your options.
Overview of Charitable Deduction Benefits
The Internal Revenue Code (Code) provide two significant tax incentives to taxpayers who wants to support charitable giving, provided they meet the compliance, record-keeping, and reporting requirements. These tax advantages help fuel charitable donations in the United States of more than $1 billion every day.[1]
First, a tax deduction is available for certain donations made to charities under Code §501(c)(3).[2] Second, appreciated capital assets that have been held for the long-term capital gain holding period receive a charitable deduction in the amount of the appreciated assets, subject to the percentage cap based on the taxpayer’s adjusted gross income.[3] Donors do not need to pay tax on this appreciation because charitable contributions are not treated as taxable sales or exchanges of donated property. A tax deduction is only available, however, if the donors itemize charitable deductions on their tax returns and meet other tax requirements.[4]
What Are Digital Assets?
Digital assets are defined to include cryptocurrency, stablecoins, and non-fungible tokens (NFTs). They are treated as “property” for tax purposes, making charitable contributions of appreciated digital assets held for the long-term capital gain holding period (that is, one year plus one day) deductible at their fair market value.[5] As recently as January 25, 2023, the IRS reiterated its position that “digital assets are not real currency (also known as “fiat”) because they are not the coin and paper money of the United States or a foreign country and are not digitally issued by a government’s central bank.”[6] The IRS defines “digital assets” to include not just convertible cryptocurrency but NFTs and some other digital items are often not thought of as digital assets.[7]
IRS Guidance on Donated Cryptocurrency
For guidance on contributing digital assets to charity, potential donors can look to Notice 2014-21; the IRS’s 2019 Frequently Asked Questions (FAQs), which were last updated on August 18, 2023; [8] and IRS Chief Counsel Memorandum (CCA) 202302012, [9] which was issued January 10, 2023.
Notice 2014-21 tells us that convertible virtual currency is treated as property for tax purposes.
Question 34 of the FAQs tells us that the donation of convertible virtual currency is not treated as a sale or exchange of a capital asset. This means that such a donation is treated the same way as other noncash contributions of property. [10]
In Question 35, the IRS addresses how to calculate the charitable deduction. [11] For capital assets held for the long-term capital gain holding period, the charitable deduction equals the fair market value of the digital assets at the time the donor makes the donation, subject to the percentage cap based on the taxpayer’s adjusted gross income. [12]
For digital assets that are not held for the long-term holding period, the charitable deduction is limited to the lesser of the donor’s tax basis or the fair market value of the donated digital assets. [13]
If the digital assets are ordinary assets in the donor’s hands, the charitable deduction is limited to the fair market value of the digital assets minus any appreciation (that is, the deduction is limited to the donor’s tax basis). [14]
If the taxpayer would have a loss on the sale of the digital assets—meaning that the donor’s tax basis is greater than the current fair market value of the digital assets—the charitable deduction is limited to the fair market value of the property. The taxpayer cannot report a capital loss on the difference between the tax basis of digital assets held at a loss and their fair market value. Because of this loss limitation, a taxpayer who holds depreciated digital assets should sell the digital assets at a loss and then donate the sales proceeds to the charity.
How to Determine Fair Market Value for Tax Purposes
To determine the amount of a charitable deduction, a donor must determine the fair market value of the digital assets to be donated. Digital assets that trade on a cryptocurrency exchange are likely to have a fair market value equal to the spot price (if such a price is available) on the date and time the digital assets are donated. If a spot price is not available—but a third party tracks and values those digital assets—fair market value is likely to be the value assigned on the applicable dates and times by that third party. For convertible digital assets (such as bitcoin and ether), it is likely that one of these methods to determine fair market value will be available.
What we know from the CCA 202302012 issued January 10, 2023 is that the donor’s ability to determine fair market value does not eliminate the need for a qualified appraisal for noncash property donations in excess of $5,000.
Fair market value is more complicated to compute for digital assets that cannot be exchanged for U.S. dollars or another fiat currency. Some of these digital assets trade on exchanges that permit one type of digital asset to be exchanged for another specified type of digital asset (also known as crypto trading pairs). In this situation, the donor must determine a justifiable pricing methodology and must have a qualified appraisal for donations in excess of $5,000.
Identification of Tax Efficient Donations
Donors might want to specifically identify those digital assets to contribute as the ones they hold with the lowest tax basis and the largest amount of unrecognized appreciation. Such a donor would be able to “mop up” on a tax-free basis the largest amount of unrecognized gain hold in their digital asset positions. To qualify for specific identification, the taxpayer must be able to identify the actual digital asset units to be donated from a particular account or digital wallet. [15] If the donor does not or cannot specifically identify the digital asset units to be donated, the donated units are treated as sold under the first-in-first-out (FIFO) inventory method.
Recordkeeping and Reporting Requirements for Crypto Donations
Because convertible virtual currency is treated as property for tax purposes, not as currency. [16] it is subject to the general tax rules that apply to charitable contributions of noncash property. [17] Again, the assumption is that these requirements apply to all digital assets.
Donors, thus, must carefully document the amount and type of their contributions, with required recordkeeping and documentation getting more extensive as their donation’s increase in value:
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For donations valued at less than $250, donors need to keep a contemporaneous receipt from the charity showing the charity’s name and address.
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Donations of more than $250 require a contemporaneous written acknowledgement from the charity. This acknowledgment must be obtained before the donor files the tax return, or before the date—including extensions—when the tax return is otherwise due. [18]
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Donations of more than $500 require a completed IRS Form 8283 (Noncash Charitable Contributions) to be filed with the donor’s tax return. [19]
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Donations of more than $5,000 also require a qualified appraisal from a qualified appraiser. [20] In addition, the charity must sign the donor’s IRS Form 8283 (Noncash Charitable Contributions) to substantiate the deduction. [21] The charity’s signature does not mean that it agrees with the appraisal value. [22] Rather, it simply acknowledges receipt of the digital asset on the date specified.
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For donations of more than $500,000, the qualified appraisal must be attached to the donor’s tax return.
Qualified Appraisals of Digital Assets
Donations of more than $5,000 require the donor to not just complete IRS Form 8283, Section B, but to also obtain a qualified appraisal that meets generally accepted appraisal standards. [23] This requirement was re-affirmed in CCA202302012, when the IRS Chief Counsel’s Office stated that a qualified appraisal is required for taxpayers to receive a deduction for donations exceeding $5,000. As a result, a donor cannot simply determine the value of the donation based on the value reported by a cryptocurrency exchange on which the digital asset is traded. Without a qualified appraisal, a charitable deduction is disallowed for donations of more than $5,000.
The qualified appraisal must be signed and dated by a qualified appraiser, defined as someone who is a recognized appraiser with at least two years’ of experience in valuing the type of property being appraised. [24] Because of the appraiser must be a “qualified appraiser,” it may be difficult (if not impossible) and possibly expensive for a taxpayer to find a qualified appraiser for certain digital asset donations.
Conclusion: Plan Ahead for Maximum Tax Savings
The path available to donors to get a charitable donation for digital assets can be a winding road. But with proper planning taxpayers can receive significant tax advantages.
[1] Giving USA, $484.85 billion: In 2021, Americans gave $484.85 billion to charity, a 4.0% increase over 2020,” https://givingusa.org/wp-content/uploads/2022/06/GivingUSA2022_Infographic.pdf, site visited February 19, 2023.
[2] Public charities under Code §501(c)(3) include, in part, entities organized and operated exclusively for religious, charitable, scientific, public safety, literary, educational purposes, amateur sports competition, and the prevention of cruelty to children or animals.
[3] Although there have been beneficial changes to charitable deductions under the 2020 CARES Act, deductions of noncash property are capped to a percentage of an individual taxpayer’s adjusted gross income. Deductions for contributions to donor-advised funds are also capped.
[4] The 2020 CARE Act permits taxpayers that do not itemize their deductions to deduct up to $300 in charitable contributions that are made in cash to charitable organizations. This above the line deduction does not apply to noncash donations such as digital assets.
[5] Code §1222(3).
[6] IRS, “Digital Assets,” https://www.irs.gov, site visited November 3, 2023.
[7] See Instructions to IRS Forms 1040 and 1040-SR.
[8] IRS Frequently Asked Questions on Virtual Currency Transactions, https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions
(last updated August 18, 2023) (hereafter FAQs).
[9] January 10, 2023.
[10] FAQ 34.
[11] FAQ 35.
[12] FAQ 35.
[13] FAQ 35.
[14] FAQ 35, See also IRS, “Charitable Contributions,” Publication 526.
[15] FAQ 40 and 41.
[16] Notice 2014-21, I.R.B. 938.
[17] Notice 2014-21, I.R.B. 938.
[18] FAQ 36, See also Publication 1771 (REV. 3-2016) Charitable Contributions, https://www.irs.gov/pub/irs-pdf/p1771.pdf.
[19] FAQ 36.
[20] IRS, CCA 202302012 (January 10, 2023).
[21] Form 8283.
[22] FAQ 36.
[23] FAQ 36; Jeremy Naylor and Brianna Reed, IRS Issues New Guidance for Virtual Currency Donations, National Law Review Volume X, Number 30, https://www.natlawreview.com/article/irsissues-new-guidance-virtual-currency-donations (Jan. 30, 2020).
[24] Allyson Versprille, IRS Update Reignites Concerns About Crypto Donation Appraisals, Bloomberg Tax https://news.bloombergtax.com/daily-tax-report/irs-updatereignites-concerns-about-crypto-donation-appraisals (Jan. 10, 2020).
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