Bitcoin’s recent parabolic rise in price is creating some interesting opportunities for not-for-profit entities and their donors. Since the IRS treats Bitcoin and other virtual currencies as property, rather than a currency, taxpayers can potentially reduce their tax bill by donating Bitcoin instead of fiat currency.
This tax-saving mechanism works because of Internal Revenue Bulletin 2014-16 combined with the rules on donating appreciated property contained in IRS Publication 526. As a result, donating virtual currency allows the taxpayer to both forgo their capital gains taxes and get a tax deduction at higher ordinary income rates.
Let’s look at an example of how this works:
Dan purchased one bitcoin for $5,000. He is a high-income earner in the top tax bracket, lives in Massachusetts, and files as a single individual. Dan held his bitcoin for over one year.
Scenario 1 – Dan Sells the Bitcoin
Because of the sale, Dan will pay more than $10,000 in taxes.
Scenario 2 – Dan Donates the Bitcoin to Charity
Alternatively, Dan decides to donate the bitcoin to his favorite 501(c)3 charity. Dan’s favorite charity does not accept Bitcoin, so Dan instead sets up a “donor advised fund” (more on this later in the article), and donates his bitcoin to the fund. Dan instructs the fund to convert the bitcoin to U.S. dollars and pay the charity the proceeds of $35,000.
Since Dan donated appreciated property, which he held for more than one year, he does not have to pay any capital gains tax on the sale. Furthermore, if Dan itemizes deductions, he can deduct the full value of the donation, saving $16,704 in taxes.
Sale vs. Donation
As a result, Dan is net out of pocket approximately $11,660 (Dan keeps $14,700 as a tax reduction instead of $26,360 in proceeds), and his favorite charity received $35,000. Effectively, Uncle Sam covered the bill for approximately $23,340 ($49,700 – $26,360) to Dan’s favorite charity.
Although this sounds great, there are some caveats.
This only works on appreciated property that the taxpayer has held for at least one year. If the taxpayer has held the property for under one year, their deduction is limited to the amount of their basis, rather than the fair market value.
This assumes that Dan was already itemizing his deductions and that he is donating to a 501(c)(3) charity.
Generally, individuals can deduct up to 50 percent of their adjusted gross income, but 20 percent or 30 percent limitations apply in some cases.
This deduction is most effective for high-income earners in high tax jurisdictions. For lower income earners in lower tax states, the concept still works, but is somewhat less lucrative.
Technically, the letter of the law states that property donations to a charity require a qualified appraisal for the donated asset. However, considering that Bitcoin and most other cryptocurrencies regularly trade on many exchanges, a market price is not difficult to establish.
Who Accepts Bitcoin Donations
Some larger charities are already on board and accept cryptocurrency donations. Some examples include:
Save the Children accepts Bitcoin, as well as seven other cryptocurrencies.
The United Way accepts Bitcoin and Ethereum donations, with all proceeds going to their “Innovation Fund”. The Innovation Fund is used to fund the development of new technologies and approaches to solve health and human services challenges.
Feeding America accepts Bitcoin, Ethereum, Bitcoin Cash, and Litecoin.
News stories about individuals losing their Bitcoin keys and hackings of exchanges are somewhat commonplace. Therefore, charitable organizations may be understandably reluctant to accept Bitcoin donations if they do not understand how it works. Fortunately, there are alternatives.
For example, the Red Cross uses BitPay, a third-party payment processor, to accept donations of both Bitcoin and Bitcoin Cash. BitPay’s processing fees are a flat 1 percent, which is likely lower than the percentage the charitable organization is paying to other payment processors such as PayPal or Visa/MasterCard. A charity can easily link its own operating account to a BitPay account, so the charitable organization receives US dollars and never directly holds cryptocurrency.
If a particular charity does not accept Bitcoin donations, individuals can set up a donor advised fund through organizations such as Fidelity Charitable. Fidelity Charitable is a 501(c)(3) public charity that advertises itself as “a smarter way to give”. Fidelity Charitable has teamed up with BitPay to accept cryptocurrency donations. Therefore, individuals can set up an account, donate Bitcoin or other cryptocurrencies to Fidelity Charitable, and take the tax deduction in the current year. The donor can then instruct Fidelity Charitable to convert their donated Bitcoin into US dollars, or other investment assets, and donate the funds to a charity of their choice in the same tax year or at a future point in time. Fidelity Charitable charges an annual administrative fee of 0.60 percent or $100, whichever is greater.
Due to the recent Bitcoin price increase, the tax benefits of donating appreciated cryptocurrency can be staggering. As society still struggles with the economic damage and human costs of COVID-19, this is an excellent time to share the wealth with your favorite not-for-profit.
Mark DiMichael Is a partner with Citrin Cooperman.