Tax Implications For Donations Of Bitcoin

Popular virtual currency Bitcoin has been a news fixture since its introduction in 2009. If fact, Bitcoin is the world’s leading virtual currency, with a market capitalization over $175 billion. This explosive growth has led donors and their advisors to explore various charitable giving opportunities using virtual currencies.

The Internal Revenue Service (IRS) describes virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and / or a store of value.” Its creators designed it to operate like legal tender, and as a medium of exchange, although very few governments currently recognize it as legal tender anywhere in the world.

Currently, Bitcoin and other virtual currencies, such as Ethereum and Ripple, represent a total market capitalization of over $250 billion. Many large charities, including large donor-advised funds and community foundations, are eager to tap into this market or have already received virtual donations. For example, United Way, American Red Cross, and the American Cancer Society accept donations of Bitcoins. Most major donor-advised funds accept Bitcoin, and some accept other cryptocurrencies as well.

Smaller nonprofits have begun accepting the currency as well. Technology and financial strategies involving the asset have only grown more complex with time, as concepts like proof-of-stake, forks, and decentralized finance (DeFi) all have become more prominent in the cryptocurrency world.

With this explosion in value, many owners of Bitcoin and other virtual currencies have significant appreciation in these assets. This makes cryptocurrency a very appealing candidate for charitable giving. This article discusses the tax treatment of Bitcoin and other cryptocurrencies under current IRS rules. It has a particular emphasis on the tax results for donations of virtual currency.

IRS Positions on Bitcoin The Internal Revenue Service was quicker than many organizations when it came to consideration of the financial and tax implications of virtual currency. In March of 2014, the IRS issued a Notice on the tax treatment of transactions involving virtual currency. This was its first official statement on cryptocurrency, although its published guidance since then has confirmed that treatment. Most importantly, the IRS stated that, for tax purposes, virtual currencies are property and not currency.

This property treatment means that traditional gain and loss principles will apply therefore treating these assets as securities or business property. A party selling, spending, or otherwise disposing of virtual currency may be subject to capital gains or ordinary income tax. Although the charity will be selling the currency, exempt organizations are not generally taxed on income, even from the sale of appreciated property.

The major tax implications for donations of virtual currency, therefore, involve the donor rather than the charity. The main consideration for donors is the charitable income tax deduction received. As a preliminary matter, note that in answering questions on donated cryptocurrency, the IRS refers multiple times to its general publication on charitable contributions. This supports the assumption that the standard noncash charitable deduction rules will apply.

The gain can be ordinary, or capital, depending on the source of the virtual currency to the donor. The determination on the type of gain or loss the taxpayer recognizes depends on whether that person held the virtual currency as a capital asset for investment purposes. If the donor did not hold the property as an investment, it would be subject to ordinary gain or loss treatment. This is more likely to be the case if the donor is a so-called “miner” or where the virtual currency is otherwise income paid for services rendered.

Results for Bitcoin and Cryptocurrency Donors These possibilities lead to three potential tax results for donors of virtual currency. First, a donor giving virtual currency held short-term (i.e., less than one year) as a capital asset will be able to deduct the lesser of cost basis or fair market value up to 50 percent of adjusted gross income. However, if the donor held the Bitcoin or other currency for more than a year as a capital asset, the deduction would be the fair market value of the gift up to 30 percent of adjusted gross income. Finally, if the currency is subject to ordinary gain or loss treatment in the hands of the donor, the donor may deduct the cost basis of the gift up to 50 percent of her adjusted gross income.

If the donor received Bitcoin as ordinary income as payment for services rendered or property sold, the donor may only deduct the cost basis under the ordinary income reduction rules. The IRS defines the cost basis of the virtual currency as its fair market value when the owner receives it. So if a third-party pays the donor Bitcoin worth $500 for professional services, and that Bitcoin later appreciated to $1,000 USD, the donor’s charitable income tax deduction would be limited to $500, or cost basis.

These rules are very favorable to donors holding appreciated virtual currency as capital assets, allowing them to avoid incurring a tax for capital gains on the Bitcoins or other currency. This is especially true following the Tax Cuts and Jobs Act of 2017, which limited Section 1031 exchanges to real estate only, meaning owners of virtual currency could not simply exchange them for other virtual currencies to avoid recognizing gain. Note that this donation would also allow the donor to avoid the potential 3.8 percent Medicare surcharge on investment income. The extreme appreciation in Bitcoin and other cryptocurrency makes the asset class a very strong candidate for charitable giving. Better still, IRS commentary has clearly laid out the tax results and requirements for substantiating such donations. Although there are some hoops to jump through to get a fair market value deduction, those difficulties can be minimal in comparison to the benefits of optimizing tax efficiency in giving. These tax items are of course not the only considerations for donations of Bitcoin or altcoins, but they can provide a powerful motivation for the right donor holding appreciated cryptocurrency.