Investment savvy individuals are taking note of the skyrocketing prices of cryptocurrency like Bitcoin over the past several months. Many may still not know much about this virtual asset or how it works, but several who have it are calling Ren to open Donor-Advised Funds with it and alleviating some of their tax burdens.
So, what is a Cryptocurrency? Cryptocurrency is a form of online or virtual money such as Bitcoin, Litecoin, Namecoin, PPCoin and Ethereum. Cryptocurrency uses cryptography for security which makes it difficult to counterfeit. Cryptocurrency is not issued by any central authority. Since prices are based on supply and demand, the rate at which a cryptocurrency can be exchanged for another currency can fluctuate wildly.
How does it work? Cryptocurrency is often overlooked as an asset that can be used to fund your Donor-Advised Fund. It’s easy to transfer and liquidate without significant cost, and since the IRS treats virtual currency as property and not currency, depending on how long you’ve held it and how you acquired it, it could be worth significantly more than you think.
It is, however, important to understand the rules to when it comes to deductions for cryptocurrency. If you acquired Bitcoin or other cryptocurrency as a long-term capital asset, and have held for more than a year, you can receive a fair market value deduction up to 30% of adjusted gross income. Much like appreciated stock, this is an ideal situation for donating your cryptocurrency. For example, Joe buys Bitcoin at $1000 and after holding it more than a year, it is now valued at $2700. If Joe donates the entire value, he may deduct up to $2700.
If it’s a capital asset and you have held it for less than a year, you will receive a deduction of the lesser of cost basis or fair market value up to 50% of adjusted gross income. So, if Bill buys Bitcoin for $600 and in just five months the value has grown to over $2000, Bill can donate the Bitcoin, but he is limited to a deduction of $600. On the other hand, if Bill buys the Bitcoin for $600 and the value declines over five months to $400, his deduction will be $400.
Finally, if you received the cryptocurrency as payment for services rendered, you may claim a deduction of the fair market value on the date you received it. For example, John performed accounting services for Mary and was paid $500 in Bitcoin. The value of the Bitcoin grows to $900. John can only claim a deduction for the fair market value at the time he received it, $500.
For donations of virtual currency over $5,000, the donor must obtain a qualified appraisal no earlier than 60 days before the date of the contribution and no later than the date of the donor’s tax return for the year of the gift.
It’s important to seek advice from your CPA regarding the characterization and tax treatment of any gains or losses before donating virtual currency.