This year feels like the first time the U.S. government got serious about crypto, and with recent actions by the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC) and Internal Revenue Service (IRS), you can’t blame investors for feeling a little nervous when filing their 2022 returns.
Crypto taxes can be confusing, even for experts in the industry. But if there was any confusion about the need to pay taxes on your crypto investments, that changed in 2020 when the IRS added it to the front page of Form 1040. As a result, many taxpayers are anxious about making sure they report their crypto taxes correctly.
Adam Nash is the co-founder and CEO of Daffy.org, a platform for charitable donations.
While there may be some debate between the SEC and the CFTC on how to regulate crypto, the IRS treats cryptocurrencies like stocks, bonds and other capital assets – and most types of crypto transactions are taxable events. So if you sold, converted, spent, earned or staked crypto you’ll need to report your gains and losses to the tax authority.
Unfortunately, without a standard 1099 (accountant speak for the form where you submit gains and losses on traders), it’s not surprising that many crypto investors have some level of dread and anxiety about potential tax issues with the crypto they hold. Further, now 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.
Understanding crypto and taxes
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: If you hold crypto for less than 365 days, then the IRS limits 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.
- Donating crypto held more than a year: 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.
When it comes to crypto and taxes, sometimes an example can help illustrate 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.
Of course, they could lighten this tax bill by donating the proceeds of the sale to charity. The couple, assuming their total income tax rate is 33.3% (24% for federal tax and California’s 9.3% state tax rate), could make a cash donation of $25,140 to get a tax reduction of $8,372.
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.
So how much does the generous couple save? If they sell the Bitcoin and donate the proceeds, they could get a tax benefit of $3,512. If they donate the bitcoin, they could get a tax benefit of $9,990. That's a difference of $6,478! By donating the bitcoin directly, the generous 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.
But here is the amazing part: The charity wins too! In the first scenario, if the couple donated the proceeds to charity, they would have only been able to donate the proceeds of the sale: $25,140. However, in the second scenario, the couple donated a bitcoin worth $30,000. Since the not-for-profit organization does not have to pay taxes, they get the full benefit of that $30,000 – a 19.3% larger gift!
CORRECTION (April 18, 2023): Corrects percentage in last paragraph and calculated savings figure three paragraphs up.