Crypto currencies are certainly in the spotlight. As of September 24, 2021, Bitcoin (BTC), the largest crypto currency, had a market cap of about $776 billion. The total market cap of all traded cryptos is about $2.1 trillion. As the cryptocurrencies become mainstream, planning issues abound in the tax area, particularly with loss harvesting and gain donations to charity. We’ll explore those two topics in light of new legislation looming on the horizon.
Crypto Tax 101. For purposes of Federal income taxes, cryptocurrency is property. That means that the sale is treated like the sale of other property, notably capital gains or losses are assessed when crypto is exchanged for real currency. If the asset is held one year or less, the resulting transaction is considered a short-term gain or loss. If held longer than one year, it generates a long-term gain or loss. The gains and losses are netted against each other, short term gain versus short-term losses, and long-term gains versus long-term losses, and then the net short-term are netted against long-term. A resulting net loss is deductible at $3,000 per year, with the balance carried forward. Net short-term gains are treated as ordinary income and net long-term gains receive special capital gains treatment. An IRS summary of gains and losses can be found here.
Basis in crypto is the purchase price, less the expenses of purchase (wallet fees and transaction costs). The adjusted sales price is the gross proceeds, less expenses of sale.
Wash Sales. Because Crypto is property, it is not subject to the ‘wash-sale’ rules. The wash sale rule stops certain transactions from harvesting losses and replacing the property early. For example, if you hold XYZ stock with a basis of $50 a share and it drops to $30 a share and you sell, it, you realize a loss of $20 a share. However, if you buy shares of XYZ within 30 days of the sale (before or after), the loss is disallowed. This rule does not apply to Crypto. If you own BTC at $40,000, and it drops to $30,000, you realize a $10,00 loss. You can buy BTC back immediately and still realize the loss. You might have bought a coin on April 5, 2021 for $60,203 and sold it on June 1, 2021 for $31,796. You’d have a $28,407 short-term loss, that you could use to offset other gains. Suppose you repurchased your BTC at the same time (note you would be out the transaction costs), your basis would reset to the new purchase price. The fact that the wash sale rule doesn’t apply helps crypto owners create a highly effective tax-harvesting strategy. But beware, some members of Congress don’t like this, and there is a new rule lurking (read on) that might change this scenario.
Charitable Contributions. An area where we’re seeing a huge uptick in interest is in making charitable donations with cryptocurrency. According to Mike McLean, Director of Investment Operations at Fidelity Charitable, Fidelity’s cryptocurrency donations are up about 300% January through September 2021. Alex Wilson, co-founder of the Giving Block, has indicated that their nonprofit participation has gone from 100 nonprofits at the beginning of 2021 to 500 as of September. “We expect 1,000 nonprofits to be on our platform by year end,” said Wilson. Wilson also observed the demographic of crypto donors is significantly different, “Many Crypto holders have 90% of their wealth tied up in currencies and haven’t made ‘check type’ donations ever. We’re seeing a whole new horizon of donors.” Wilson relates the story of the Pineapple fund, where an anonymous donor gave $56 million of Bitcoin to 50 nonprofits in 2017. He explained that the donation, in turn, led to the creation of Giving Block to facilitate crypto charitable contributions.
Mechanics of Crypto Donations. Fidelity and Giving Block handle donations differently. Giving Block sets up a wallet for the nonprofit and accepts donations 24/7. It liquidates the currency (less its fee) and credits the nonprofit’s wallet. Fidelity uses its digital wallet and moves the funds to a Donor Advised Fund (DAF). Fidelity sells the donation currency during New York Stock Exchange hours. The costs vary between the options. Because cryptocurrency is considered property, crypto charitable donations over $5,000 must have an appraisal. Josh Lefcowitz, CPA, and partner in charge of valuation services at Cohen & Company, observed, “People may have experience with donating appreciated publicly traded stocks, which are a special exception to the appraisal requirement. The tax code specifically states that only ‘stock of a corporation’ is eligible for the exception. There are complexities around valuing cryptocurrency due to multiple markets, necessitating the use of a price aggregator tool. Additionally, the appraisal is still required for gifts over $5,000 and that costs time and money.” Both Wilson of Giving Block and McLean at Fidelity highly recommend appraisals to accompany the IRS form 8283.
To be eligible for a fair market value deduction, the property must be held for longer than one year. Specific lot identification becomes very important in the digital wallet for which currency is being donated. Apps like ZenLedger and CoinTracker allow specific lot identification. If a wallet had one coin from April 24, 2020 at $7,543 and another coin from April 9, 2021 at $59,778, the holder could donate the April 2020 coin and get a fair market value deduction (say $41,134), which they could deduct, and avoid capital gains taxes on $33,591 of capital gains. They could also sell the April 2021 coin and receive a short-term capital loss of $18,644, which they could offset against other gain and use at a rate of $3,000 a year. There is a profound difference between the outcomes depending on which coin is donated and which is sold. If the holder did the reverse (donated the 2021 coin and sold the 2020 coin), they’d pay capital gains taxes on the 2020 coin and have no loss carryover, plus lose the loss on the depreciated coin from 2021.
Storm Cloud: The 09/13/2021 House Ways and Means Committee’s proposal on taxes seeks to eliminate the wash sale exclusion for crypto. As the proposal wends its way through the legislative process, changes and developments are par for the course, If the proposal becomes law, the effective date would be 12/31/2021, so time to use the wash exemption may be limited.
Bottom Line: As Crypto becomes more mainstream, holders need to be vigilant of the developments in tax rules and crypto charitable opportunities. With prospective new legislation on the horizon, familiarize yourself with the rules, or find and expert who can help. As always, I’ll try to answer questions firstname.lastname@example.org.