Capital Gains Tax and Cryptocurrency
Cryptocurrency donations to charities were booming in 2021 and continue in 2022. Digital assets donations on Giving Tuesday grew 583% in 2021 from Giving Tuesday in 2020 and should grow even more in 2022. The Internal Revenue Service defines Bitcoin and other digital cash as property, not currency. If a client purchases cryptocurrency for personal or investment purposes, any profits from the purchase and sale are subject to capital gains to either short-term or long-term capital gains tax depending on the length of time the assets are held. Usually, crypto investors hold these assets for a short time, but 12 months is the threshold. A taxable event is triggered when cryptocurrency is exchanged for a different brand of cryptocurrency or fiat currency. However, if the individual is in the business of selling or mining virtual assets, ordinary income tax rates apply. Additionally, under the Tax Cuts and Jobs Act of 2017, cryptocurrency holders cannot use like-kind exchanges to defer capital gains.
But cryptocurrency investors may be able to bypass capital gains taxes on profitable assets and get a tax write off if they make charitable contributions using cryptocurrency assets and itemize deductions. If an investor donates highly appreciated cryptocurrency directly to a charity, the charity will receive full value of the cryptocurrency and the client will receive a charitable income tax deduction for the fair market value. The charity will not be subject to any capital gains tax on the appreciated value. The investor could also donate to a donor advised fund which accepts cryptocurrency to have the same result.
Popularity of Charitable Cryptocurrency Donations
Part of the reason for the growth of cryptocurrency charitable donations may be the unprecedented growth of digital assets. The price of Bitcoin, for example, has risen approximately 70% since the start of 2021. The growing popularity of such charitable contributions is great news for philanthropic organizations. Cryptocurrency investors are a disproportionately charitable group from more typical investors. In fact, 88% of Millennials tend to be charitably inclined compared to 71% of Gen Xers and 60% of Baby Boomers. Additionally, Millennials also tend to invest more in cryptocurrency than the other generations. Studies show that 47% of younger investors believe cryptocurrency is a smart investment and 35% say they own cryptocurrency. Also, among those who don’t own any, another 50% say they plan to invest in the next year. Alternatively, only 13% of total investors hold cryptocurrency and 20% of those who don’t plan to invest in the next year.
Investing in cryptocurrency is rising, but the tax savvy strategy of donating cryptocurrency to charities is not commonly known and understood. While a significant portion of cryptocurrency investors have donated digital assets to charity, many have faced significant difficulties. For example, some charities require larger amount donations of digital assets than the donor wants to contribute; many nonprofits and charities do not accept donations of cryptocurrency; and the process can be quite cumbersome. However, as the popularity of cryptocurrency investing and cryptocurrency charitable contributions grows, more charitable organizations and also Donor Advised Funds (DAFs) are accepting crypto asset contributions.
The IRS requires donors to take charitable deductions at the fair market value of the donated property. Donating cryptocurrency is not as straightforward as donating publicly traded stocks. Because the IRS has designated cryptocurrency as property and not currency, a donation of cryptocurrency that exceeds $5,000 requires a qualified appraisal which must meet IRS requirements. A qualified appraiser must be used who has met education and experience requirements.
Qualified appraisers are typically licensed or certified in the state where the property is located. The appraisal must occur no more than 60 days prior to the donation transaction date and no later than the due date of the tax return and any extensions. The appraisal is reported on IRS Form 8283 and the appraiser must sign the form in order to obtain a deduction. It can be difficult to find a qualified appraiser, but as the demand grows, so does the pool of appraisers.
As crypto assets become increasingly accessible, advisors such as attorneys and financial advisors are needed to provide guidance. This will become important as advisors prepare for a huge transfer of wealth to the next generation—Millennial clients. Again, because millennials are disproportionately charitable and disproportionately investing in cryptocurrency, charitable strategy guidance in these assets is necessary.
The Nonprofit Community
Many nonprofit organizations have been hesitant or have refused cryptocurrency donations. But the landscape is changing, and digital assets are likely to become a strong funding source going forward. Nonprofits will need to change development efforts and learn to navigate cryptocurrency investments. Nonprofits face a variety of challenges including cryptocurrency investment volatility, enabling seamless donations, exchanging donations to traditional currency and ensuring security for the organizations and the donors. If a nonprofit ignores the trend, the organization will miss out on charitable donations to another nonprofit organization’s gain. As Millennials grow to include a signification portion of the donor base, nonprofits who embrace cryptocurrency will be well positioned for the future.
Cryptocurrency Planned Gifts
For wealthy donors, crypto assets can be transferred to charitable organizations through various charitable giving vehicles in the same way more traditional investments are transferred. Gift annuities can be funded with cryptocurrency through a charity’s internal wallet. Charitable Remainder Trusts can be funded with a wallet specifically for the trust with an EIN number to create the account. The wallets keep the private keys—the passwords that give access to cryptocurrencies and prove ownership of digital assets. Charitable Remainder Trusts are also used for large volume donations or to hold and trade cryptocurrency. Finally, individuals can leave charitable gifts of crypto assets through wills or trusts which are typically printed, signed and stored in a vault or somewhere safe and secure.
There are many factors to consider when planning your estate. KJK’s Estate, Wealth & Succession Planning attorneys can help you navigate through the process. If you have any questions about this article or would like assistance with planning your future in general, please contact Susie Friedman (SLF@kjk.com; 216.736.7272).