On January 13, 2023, the Internal Revenue Service (IRS) released a memorandum (CCA 202302012) concluding that a qualified appraisal is required when a taxpayer claims a charitable contribution deduction exceeding $5,000 for donated cryptocurrency. Valuations reported by cryptocurrency exchanges do not qualify as “qualified appraisals.” The memorandum is relevant to any taxpayer who has donated (or plans to donate) cryptocurrency if they also intend to claim a charitable deduction.
SUBSTANTIATION REQUIREMENTS FOR CHARITABLE CONTRIBUTION DEDUCTIONS
Internal Revenue Code Section 170 generally allows deductions for charitable contributions in the taxable year that the contributions are made. However, these deductions are allowed only if they are verified under US Department of the Treasury (Treasury) regulations. Deductions may be denied if the taxpayer does not meet certain substantiation requirements outlined in Section 170(f)(11).
The substantiation requirements for charitable contribution deductions generally require that, for contributions of property for which a deduction of more than $5,000 is claimed, the taxpayer must obtain a “qualified appraisal” of the property.
MEETING THE QUALIFIED APPRAISAL REQUIREMENT
An appraisal can only be qualified if it is conducted by a qualified appraiser in accordance with generally accepted appraisal standards. To be qualified, an appraiser must (1) be an individual, (2) have earned an appraisal designation from a recognized professional appraiser organization or meet minimum education and experience requirements set by the Treasury or the IRS, and (3) regularly perform appraisals for which he or she receives compensation.
Furthermore, the appraisal must not be made and signed by the appraiser sooner than 60 days before the donation or later than the due date (with extensions) of the tax return on which the deduction is claimed. The qualified appraiser must sign and date the appraisal report and include a declaration that such person (1) understands the appraisal will be used in connection with a return or claim for refund, (2) understands that such person may be subject to a penalty if the appraisal contains a substantial or gross valuation misstatement of the value of the property and the taxpayer claims a deduction based on the appraisal, and (3) has not, within the past three years, been barred from presenting evidence or testimony before the Treasury or the IRS. The appraiser may not receive a fee that is based to any extent on the appraised value of the property.
EXCEPTIONS TO THE QUALIFIED APPRAISAL REQUIREMENT
While the qualified appraisal requirement may seem to impose an onerous burden on taxpayers, given the philanthropic purpose of charitable donations, this is mitigated by rules excepting certain readily valued property from the qualified appraisal requirement. For example, a taxpayer is not required to obtain a qualified appraisal for cash donations, stock in trade, inventory, inventory property, publicly traded securities and certain vehicles.
Notably, “publicly traded securities” for this purpose is limited to mean corporate stock; a right to subscribe for or to receive a share of corporate stock; or a bond, debenture, note, certificate, or other evidence of indebtedness issued by a corporation, a government or a political subdivision thereof.
Failure to properly comply with the appraisal requirements will not result in denial of the deduction if the taxpayer establishes the failure was due to “reasonable cause” rather than “willful neglect.” However, such reasonable cause exception will not apply to the extent no appraisal was obtained.
CRYPTOCURRENCY, CRYPTO DONATIONS AND THE QUALIFIED APPRAISAL REQUIREMENT
Cryptocurrency (also referred to as digital assets, virtual currency, tokens or coins) uses cryptography to secure transactions that are digitally recorded on a distributed ledger such as a blockchain. While virtual currencies can be used as payment for goods and services and can be freely traded on public exchanges and exchanged into other currencies or digital assets, the IRS does not treat these assets as currency (also known as fiat), but rather as property.
While cryptocurrency may experience value fluctuations similar to assets such as stocks or bonds, the value attributed to cryptocurrency is different. Specifically, stocks represent a company’s fractional ownership, while bonds represent the value of debt that will be repaid upon maturity. In contrast, the value of a particular cryptocurrency often simply reflects the amount that people are willing to pay for it. This distinction can create problems for prospective donors.
While taxpayers may wish to donate their cryptocurrency to charitable organizations, claiming deductions for these donations may implicate hurdles that would not ordinarily apply to the donation of more conventional publicly traded assets. Cryptocurrency is not cash, a publicly traded security (as defined above) or any other listed type of readily valued property. Accordingly, taxpayers donating cryptocurrency may not rely on the readily valued exception to the qualified appraisal requirement and must seek a “qualified appraisal” to be eligible for cryptocurrency donation deductions exceeding $5,000.
In June 2022, the Lummis-Gillibrand Responsible Financial Innovation Act was introduced and required the IRS to issue guidance removing the appraisal requirement for digital assets for contributions exceeding $5,000 as readily valued property not requiring a qualified appraisal. However, the bill has not made much traction in US Congress as of this date.
Because cryptocurrency is not considered readily valued property, taxpayers who wish to donate more than $5,000 in cryptocurrency seem to be left with few options: either obtain a qualified appraisal that meets the IRS’s requirements or forgo deductions for the donated cryptocurrency. While none of these options are particularly convenient for the prospective donor, relief may be on the way if sufficient interest in cryptocurrency donations can create a market for qualified appraisers.
Anthony Teng, a law clerk in the New York office, also contributed to this article.