IRS addresses deductions for losses, charitable contributions of cryptocurrency

In detail

Digital assets are assets that do not exist in physical form and include “convertible virtual currency” and “cryptocurrency.”  The IRS previously has indicated that cryptocurrency is one type of digital asset and that it should be treated as property under general tax principles. As such, sales, exchanges, and other dispositions of digital assets may result in recognition of gain or loss, and digital assets can be donated to charity, similar to other types of noncash property.

Some digital assets represent rights to “real world” assets, such as real property, actively traded personal property (like gold) or shares in a legal entity (like a corporation or a partnership). Section 165(g)(2) defines “security” as “a share of stock in a corporation; a right to subscribe for, or to receive a share of stock in a corporation; or a bond, debenture, note, or certificate … issued by a corporation, government, or political subdivision thereof with interest coupons or in registered form.”

Observation: In both CCAs, the IRS factually states that the particular units of cryptocurrency in question did not satisfy the definition of a "security." Characterization of a particular digital asset depends on the facts and circumstances related to that digital asset.

Charitable contributions of cryptocurrency

The IRS received a request for non-taxpayer specific advice regarding a contribution of cryptocurrency reported on Part I, Section B of Form 8283 for $10,000. The deduction amount was based on the value listed on the cryptocurrency exchange used to facilitate the contribution at the date and time of the donation. A qualified appraisal was not included with the return, and the taxpayer argued that an appraisal was not required as the cryptocurrency donated had a readily ascertainable value based on the information provided by the exchange.

For individual taxpayers to claim charitable contributions as itemized deductions on their income tax returns, they must substantiate the contributions. If a taxpayer claims a deduction of more than $5,000, they must acquire a qualified appraisal under Section 170(f)(11)(C). However, there are certain types of “readily valued” property that do not require an appraisal, regardless of the amount of the contribution; these include cash, stock in trade, inventory, property held for sale to customers in the ordinary course of business, “publicly traded securities,” intellectual property, and vehicles.

The IRS determined that the cryptocurrency addressed in CCA 202302012 did not meet the definition of a publicly traded security, and therefore, was not exempt from the qualified appraisal requirement. Additionally, the IRS said the cryptocurrency in question did not meet the definition of cash or any other type of property listed in Section 170(f)(11)(A)(ii)(I) and Treas. Reg. Sec. 1.170A-16(d)(2)(i). For these reasons, a qualified appraisal was required for donations of the cryptocurrency over $5,000.

Observation: The IRS and courts strictly enforce the substantiation rules under Section 170. In meeting the requirements for a qualified appraisal, taxpayers should obtain an appraisal that is treated as qualified under the regulations and that has been conducted by a qualified appraiser. Under the regulations, a qualified appraisal must include a sufficiently detailed description of the property, the effective date of the valuation, the date of the contribution, the fair market value of the property on the effective date of the valuation, and the terms of any agreement between the donor and donee relating to the use of the contributed property. The appraisal also must include language indicating that it was prepared for income tax purposes, the method of valuation, and the basis for the valuation. The appraiser must have an appraisal designation from a recognized appraiser organization and must regularly perform appraisals for which they receive compensation.

While there is a reasonable cause exception to the qualified appraisal requirement, the exception is viewed as intended to provide relief to taxpayers who attempted to comply with the appraisal requirement but were unsuccessful, and is not meant to provide taxpayers with an opportunity to opt-out of obtaining a qualified appraisal. As such, the claim that cryptocurrency has a readily ascertainable value because of its listing on a cryptocurrency exchange was held by the IRS as not meeting the reasonable cause exception.

In the CCA, the IRS looked to Pankratz v. Commissioner, where the taxpayer failed to attach qualified appraisals of donated property to his return and sought to invoke the reasonable cause exception, claiming that he had relied on the advice of professionals in preparing his return. The Tax Court held that the exception would not apply because the taxpayer did not rely on qualified professionals, noting that if he had reviewed his return, the language on the Form 8283 would have indicated to him appraisals were necessary. The Tax Court stated “[w]e think that four mentions of 'appraisal', 'appraiser', or 'appraised' on one page of one form is pretty good notice that substantial noncash donations need to be backed up by an appraisal.” 

In the fact pattern in this CCA, the taxpayer attached a partially completed Form 8283 to a self-prepared return and did not simply disregard/ignore the mention of appraisal; the taxpayer did not believe the requirement applied because of the readily available value of cryptocurrency. The IRS states that “the reasonable cause exception was not intended to provide taxpayers with the choice of whether to obtain a qualified appraisal, but to provide relief where an unsuccessful attempt was made in good faith to comply with the requirements of [S]ection 170”.