2022 is the year when the US government has shown its seriousness towards cryptocurrency. Recent actions by the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), and Internal Revenue Service (IRS) have made investors nervous when filing their returns. Crypto taxes can be complicated, even for industry experts. However, the IRS has made it mandatory to pay taxes on crypto investments, and it has been added to the front page of Form 1040. As a result, taxpayers are worried about reporting their crypto taxes accurately.
Adam Nash, the CEO and co-founder of Daffy.org, a platform for charitable donations, says that while there may be a debate between the SEC and the CFTC on how to regulate crypto, the IRS treats cryptocurrencies like capital assets, such as stocks and bonds. Most types of crypto transactions are taxable events, and if you have sold, converted, spent, earned, or staked crypto, you must report your gains and losses to the tax authority. Unfortunately, without a standard 1099 form, many crypto investors have anxiety and dread about potential tax issues with the crypto they hold. Additionally, now that the IRS is better funded, the penalty for even honest mistakes feels higher.
However, there is a reliable and legal way to avoid many of the issues related to filing taxes for crypto transactions: making charitable donations. If you are fortunate enough to hold crypto that has appreciated in value for more than one year, you can donate it. You won’t need to worry about paying capital gains taxes, and you’ll reap the benefits of one of the most generous deductions in the tax code.
As per the IRS guidelines, crypto and other digital assets are classified as property (like stock), and cryptocurrency transactions are subject to capital gains taxes. Crypto held for less than one year that appreciates in value is subject to the short-term capital gains tax, which is the same rate as income taxes. Meanwhile, crypto held for more than a year that appreciates in value would qualify as “long-term,” which generally offers lower tax rates. The length of time you have held an asset is very important when it comes to donating assets.
The IRS has very different rules for assets that have been held short-term vs. long-term. Donating crypto held less than a year would limit your deduction to the fair market value of the asset minus the capital gain. As a result, donating assets like stock or crypto that have been held for less than a year makes very little sense. If it is below your purchase price, you would lose out on claiming the capital loss. If it is above your purchase price, you lose out on the value of the gain.
When you donate crypto that you have held for more than a year to a qualified public charity, the IRS considers the donation value to be the fair market value of the asset at the time, not the value you paid for it – the current fair market value. If you itemize your tax deductions, this means donating appreciated crypto can result in money saved for the taxpayer and more money for the charity. The charitable deduction is one of the most generous in the tax code, allowing taxpayers to deduct donations of assets up to 30% of their adjusted gross income (AGI) in any given year.
Let’s take an example to understand how this simple strategy could work. Imagine a couple that has an adjusted gross income (AGI) of $250,000 per year who purchased a whole bitcoin (BTC) in February 2020 for $10,000, and then decided to sell it in April 2023 for $30,000. In a state like California, a couple earning $250,000 might be in a 15% federal tax bracket for long-term capital gains in addition to a 9.3% California tax bracket, for a total of 24.3%. Since that couple purchased BTC at $10,000 and then sold it for $30,000 after holding it for more than a year, they would owe a total of $4,860 in taxes on a reported gain of $20,000, leaving them with an after-tax gain of $15,140.
The couple could lighten this tax bill by donating the proceeds of the sale to charity. Assuming their total income tax rate is 33.3% (24% for federal tax and California’s 9.3% state tax rate), they could make a cash donation of $15,140 to get a tax reduction of $5,041. However, the numbers are much better for our couple and the charities they support if they donate the bitcoin directly. Donating 1 BTC with a fair market value of $30,000 to charity would allow the couple to deduct $30,000 off of their income. At their 33.3% tax rate, that would potentially save them $9,990 in taxes. If they sold the bitcoin, it would have incurred a capital gains tax of $14,850. That means, by donating, the couple wins twice because they (1) get a tax deduction for the larger donation, and (2) they never have to pay capital gains taxes on the appreciation of their bitcoin.
The charity also benefits from this donation. If the couple donated the proceeds to charity, they would have only been able to donate the proceeds of the sale: $15,140. However, if they donated a bitcoin worth $30,000, the not-for-profit organization would get the full benefit of that $30,000 – a 98.2% larger gift!
In conclusion, crypto investors must pay attention to the tax implications of their investments. The IRS treats cryptocurrencies as capital assets, and most types of crypto transactions are taxable events. However, making charitable donations can be a reliable and legal way to avoid many of the issues related to filing taxes for crypto transactions. Donating appreciated crypto can result in money saved for the taxpayer and more money for the charity. The charitable deduction is one of the most generous in the tax code, allowing taxpayers to deduct donations of assets up to 30% of their adjusted gross income (AGI) in any given year.