Recently, the cryptocurrency space has grown exponentially, with digital assets becoming a significant part of the financial landscape. As this new financial realm continues to evolve, so does the need for clear tax guidance on various aspects of cryptocurrency transactions. One area of interest to many cryptocurrency holders is charitable contributions made using digital assets. In a recent advisory (CCA 202302012), the IRS has clarified its position on this matter.
In a nutshell, the IRS advisory addressed two key questions:
1. Is a qualified appraisal required for contributions of cryptocurrency where the charitable contribution deduction claimed exceeds $5,000?
2. If such an appraisal is required, and it isn’t obtained, does the “reasonable cause” exception apply if the value of the cryptocurrency is determined based on the reported value by a cryptocurrency exchange?
Let’s dive deeper into these questions.
Are Qualified Appraisals Required?
The answer is yes. If a taxpayer donates cryptocurrency and claims a charitable contribution deduction of more than $5,000, they are required to obtain a qualified appraisal under §170(f)(11)(C) of the Internal Revenue Code. This is necessary to qualify for a deduction under §170(a).
This follows the general guidance from IRS Notice 2014-21, in which the IRS broadly defined all cryptocurrency (also called “virtual currency” or “digital assets”) as property for tax reporting purposes.
The “Reasonable Cause” Exception
The “reasonable cause” exception does not apply if a taxpayer determines the value of the donated cryptocurrency based on the reported value by a cryptocurrency exchange, instead of obtaining a qualified appraisal. If a taxpayer fails to comply with the qualified appraisal requirement, they are not permitted to claim a charitable contribution deduction under §170(a).
What Does this Mean?
The implications are straightforward. If you’re a cryptocurrency holder looking to donate a significant amount to charity and claim it as a deduction, it is essential to get a qualified appraisal of the cryptocurrency being donated. Relying on exchange-reported values will not suffice for tax purposes.
In the given case study, a taxpayer donated “cryptocurrency B” to a charitable organization. She claimed a charitable contribution deduction of $10,000 based on a value listed at the cryptocurrency exchange where “cryptocurrency B” was traded. The taxpayer did not obtain a qualified appraisal for the donation, arguing that it was unnecessary because “cryptocurrency B” had a readily ascertainable value based on the value published by the cryptocurrency exchange.
The IRS advisory, however, clarified that such a claim doesn’t establish reasonable cause for failing to obtain a qualified appraisal.
Treatment of Crypto Donations vs. Stock Donations
In our practice, we often get asked about the difference between how crypto donations are valued compared to stock donations. While both are traded openly on exchanges, there are major differences when comparing the two types of donations.
Donations of Stock:
• When publicly-traded stocks are donated, the IRS allows the donor to deduct the full fair market value of the stock from their income taxes, provided the stocks have been held for more than one year.
• The fair market value is usually determined by the average of the high and low selling prices on the date of the gift or by the market price received by the donee organization when the stock is sold.
• Importantly, publicly-traded stocks are one of the few types of donated property for which the taxpayer is not required to obtain a qualified appraisal, even if the donation value exceeds $5,000.
Donations of Cryptocurrency:
• Like stocks, the IRS classifies cryptocurrency as property, which means that you can claim a deduction for the fair market value of the donated cryptocurrency. However, the key difference lies in determining this fair market value.
• In contrast to stock donations, for cryptocurrency donations exceeding $5,000, the IRS requires a qualified appraisal to substantiate the claimed value.
• The use of exchange-reported values for valuation, a common practice by crypto owners, will not suffice for tax purposes if the donation exceeds $5,000.
So while both stock and cryptocurrency are considered property for tax purposes, their treatment in terms of donations varies significantly. The main difference lies in the valuation and documentation requirements for substantial donations, which are more rigorous for cryptocurrency than for stocks. This difference makes it crucial for cryptocurrency donors to obtain a qualified appraisal to ensure tax compliance and full deduction benefits.
Conclusion
The IRS has made it clear that it considers digital assets like cryptocurrencies as property for tax purposes. When making charitable donations exceeding $5,000, the onus is on the taxpayer to obtain a qualified appraisal to ensure compliance with IRS rules.
As cryptocurrency continues to penetrate mainstream finance, expect to see further IRS advisories clarifying how traditional tax principles apply. It’s crucial to stay informed and consult with tax professionals to navigate the tax landscape successfully.