With virtual currency (VC) gaining in popularity, charitable organizations have begun accepting VC donations. Large charities such as the United Way and UNICEF were among the first to accept VC donations. While charitable intent starts with the altruistic desire to help a particular cause, the tax benefit that a charitable contribution deduction gives the donor is certainly welcome.
Donating VC then begs the question of how exactly the charitable deduction is determined. Noncash donations come in two broad categories: those that would generate ordinary or short-term capital income/loss if sold and those that would generate a long-term capital gain/loss if sold.
In general, the deduction for ordinary or short-term income assets is limited to the lesser of the donor’s cost basis or its fair market value. The donation for long-term capital gain property is equal to the fair market value; to the extent the asset appreciated, that gain escapes tax. There are overall limitations of how much can be deducted in any one year, based on the individual’s adjusted gross income.
The Internal Revenue Service (IRS) has issued guidance indicating that VC is considered property for tax purposes, and that its disposition is capital in nature. Therefore, donating VC is deductible identically to the way stock donations are treated, as follows:
If the VC was held for one year or less, the deduction is limited to its fair market value, or cost basis, whichever is lower. To the extent the fair value is greater than cost, that excess generates no tax benefit to the donor.
If the VC was held for more than one year, the deduction is equal to its fair market value. To the extent the fair value is greater than cost, that built-in gain is not taxed and the donor gets the best of both worlds—deducting the full value without paying tax on the appreciation.
For both categories of holding period, to the extent the cost is greater than the value, it is better for the donor to first sell the VC to be able to capture that loss. The donor should then donate the cash proceeds to the charity. Otherwise, the built-in loss generates no tax benefit.
The donation is reported as part of the donor’s income tax filing on form 8283. When the total VC donations are greater than $5,000, VC and stock part ways. Stock donations do not require an appraisal nor the appraiser’s and donee’s signatures on the form, so long as the securities in question are traded on a public exchange.
A “security” for charitable reporting purposes uses the definition found in IRC 165(g)(2), which defines the term to mean stock, bonds, debentures, notes, and other evidence of indebtedness. Virtual currency does not fit any of these definitions. Even if it did, the question of whether VC is considered to be traded on a public exchange is debatable. Thus, the donation of more than $5,000 of virtual currency would require obtaining an independent qualified appraisal and having both the appraiser and donee sign the form.
A qualified appraisal means a document produced by an independent appraiser who has the qualifications to opine on the value of the donation. The appraisal must contain specific elements as spelled out in the Internal Revenue Code. Thus, it cannot be simply a screenshot of the VC’s value the donor happens to find on the internet. As is the case with any donation requiring an appraisal, the appraisal must accompany the form as part of the tax return.
If any of the reporting requirements is not present—a qualified appraisal, the appraiser signature, and the donee signature—the IRS is on solid ground to disallow the deduction. Ample case law exists to prevent the donor from furnishing the required information after the fact.
Perhaps, in time, regulations will be written to expressly put donations of VC on the same reporting footing as stock, but until that day arrives, obtaining a qualified appraisal and the requisite signatures is the best way to ensure the donation is not summarily disallowed.
For questions on virtual currency matters, please contact Larry Rubin, Aronson’s tax controversy practice lead partner, at 301.222.8212.