Dave Lemke, CPA
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Apr 20, 2022
If you’re reading this, that means either that you couldn’t get enough of What the Heck Is Tax Basis? (Part 1) or you’re looking for another dose of tax accounting principles to solve your insomnia. Either way, this builds on that first article, so flip through that first if you haven’t already. We’re covering two nifty planning tricks and pitfalls to avoid when it comes to the tax basis of your crypto holdings.
Donations in Kind
One of the most powerful tools in the tax code is an “in-kind” donation to a charitable organization. This means giving something directly to a charity instead of selling it first, paying tax on the gain, and donating the cash. The enormous tax benefit of in-kind donations is that not only do you avoid paying tax on the appreciation1 but also you get to deduct the full fair market value (FMV) at the time the asset was donated. This double-whammy tax benefit is what allows the uber-wealthy to erase enormous amounts of taxable income. For example, Warren Buffet could wipe off about half a million dollars of his income by donating a single share of Berkshire Hathaway to charity and at the same time avoid tax on the appreciation.
Two important things to keep in mind before you take advantage of this approach:
Make sure that the organization you’re donating to is actually an IRS-certified charitable organization. You can check an organization’s tax-exempt status online, and the company should always provide you with a receipt with its tax ID number and the magical phrase, “No goods or services were provided in exchange for this donation.”
If you donate to non-exempt entities like your local little-league baseball team, a friend’s Go Fund Me campaign, or directly to the Ukrainian government, you won’t be able to write it off for tax purposes. But you still are a very nice person.
Only assets that you’ve held for over a year get the benefit of deducting the full FMV.2 Otherwise, you can only deduct your tax basis in the asset, not the FMV. Womp womp.
Cryptocurrencies generally qualify for this special tax treatment. You can check with your favorite charity to see if they have a wallet address to accept crypto donations. There are also third-party processors such as Crypto for Charity that collect a small fee to process in-kind crypto donations on a charity’s behalf.
Once you make a donation in kind, you’ll need to file Form 8283 to claim the deduction when you file your personal tax return and keep receipts of the donation to document your tax basis and the FMV when you donated. Cryptocurrencies are not considered publicly traded stocks or securities, so if you donate more than $5,000 of crypto to a charity you may need to get a qualified appraisal.
As with most great tax strategies, this would be an ideal time to get a CPA involved to check the nitty-gritty details and verify that you’re getting the greatest tax benefit out of your charitable contributions.
Wash Sales
No, the term “wash sales” is not referring to the quarters you spend at your local laundromat. This is a technique that you can use to realize a tax loss currently without changing your investment strategy or portfolio.
For example, say that you invested in a promising new token that you are diamond-hands sure will be the next Bitcoin. But, alas, so far the value is much lower than when you originally bought it. To get the benefit of that loss, you could sell your investment and then immediately buy it back. This would trigger a tax loss on your personal income tax return currently rather than waiting years to see how it actually turned out. This is known as a wash sale.
The tax code disallows this strategy3 for stocks and other types of investments, but not for crypto. But heads up! The Build Back Better bill (which stalled in the Senate in 2021) proposed language to subject crypto assets to the wash sales rules. Stay tuned to see if legislation is enacted for 2022 or forward that disallows wash sales for crypto assets.
Doing a wash sale is not always wise. It resets your holding period and resets your tax basis which could cause problems down the road. Let’s look at the following example:
Jan. 1, 20X1 – you buy Lemke Token (not a thing) for USD $1,000.
Dec. 31, 20X2 – value tanks to $250, so you sell and immediately repurchase to recognize a $750 capital loss on your 20X2 personal tax return.
Jan. 1, 20X3 – value skyrockets to $10,000, just like you always knew would happen and you sell to lock in the gain.
In this scenario, the problem with the wash sale in year 2 is that it causes almost double the tax on the gain in year 3. Instead of having $9,000 of long-term capital gain, you have $9,750 of short-term capital gain. This means you could be paying around twice as much tax on the gain because long-term capital gains are taxed at much lower rates than short-term.
As always, make sure you’re chatting with a tax professional about your investment strategy to make sure you’ve got the latest & greatest updates on the tax law and what will reap the most reward in your specific scenario.
Footnotes
Assets that have gone down in value generally should be sold first to recognize the tax loss and then donate the cash to charity for maximum tax benefit.
IRC §170(e)(1)(A)
IRC §1091
