IRS Decides Bitcoin is “Property.” What Does this Mean for Nonprofits?
Nonprofits should be aware of some recent developments in the IRS treatment of Bitcoin. The IRS recently decided Bitcoin would be treated as property under US tax law. What does that mean for nonprofits who want to receive contributions of Bitcoin? And what does it mean for donors wishing to make contributions in Bitcoin?
Before discussing the implications of the IRS’ treatment, we must answer the fundamental question: What is a Bitcoin?
Bitcoin is a virtual currency created in 2009 by an unknown person or persons using the penname “Satoshi Nakamoto.” The IRS defines virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.”[1] Bitcoin is decentralized, meaning it is not controlled by any government or organization. Rather, Bitcoin was designed so that control of Bitcoin is vested in Bitcoin users all over the world.
Instead of being printed like traditional currency, Bitcoin are discovered and created through “mining.” This can be done by any person who owns the computing equipment necessary to perform the operations needed to solve complicated mathematical calculations. The creator of Bitcoin implemented an incredibly complex algorithm which allows Bitcoin to be mined at a predictable rate. The more people mining at the same time, the harder it will be for an individual or group of people to successfully retrieve any Bitcoin.
Today, mining is most commonly performed by tech savvy individuals who gather together in “pools” to coordinate their efforts and maximize their efficiency. In a pool, miners are given smaller and easier algorithms to solve, and all of the combined work makes it more likely that the pool will solve the bigger algorithm and earn Bitcoins.Each Bitcoin has a unique address, preventing Bitcoins from being fraudulently copied or stolen.
Transacting with others in bitcoin requires ownership of a “bitcoin wallet.” Bitcoin wallets can be installed on a computer like software or can be made mobile for use on a mobile phone. The purpose of a bitcoin wallet is to save bitcoin addresses—the information needed to transfer bitcoins.
Because Bitcoin is property, the IRS will view Bitcoin as either a capital or non-capital asset depending on “the taxpayer’s use of bitcoin or the activity from which the taxpayer earns bitcoin.”[2] This is significant because the disposition of a capital asset is generally taxed at a lower rate than the disposition of a non-capital asset.
Practically speaking, few taxpayers use and acquire Bitcoin in a manner that would result in the classification of Bitcoin as a non-capital asset. These are limited to Bitcoin miners, dealers, and a few others. Most taxpayers will generate income by disposing of Bitcoin that was purchased or received from a previous holder. Bitcoin acquired in this manner will be classified as a capital asset. Every disposition of Bitcoin held as a capital asset results in a taxable event. Taxpayers who hold Bitcoin as a capital asset are expected to keep track of their basis in Bitcoin, as well as the Bitcoin’s fair market value on the day and time it was spent, to determine whether a disposition results in a gain or loss.
Bitcoin’s promoters tout Bitcoin as “a new kind of money.” But is it? Bitcoin’s property designation makes it unlikely that it will gain widespread acceptance for everyday transactions in the near future. As a result, some Bitcoin holders may be more inclined to donate it to charity to avoid the hassle involved in calculating their gain.
As far as nonprofits are concerned, there doesn’t seem to be any downside to accepting these contributions at this time. A contribution of Bitcoin is essentially a contribution of property. The donee nonprofit is unconcerned about capital gains and can immediately convert the donation to cash. Acceptance of these contributions may broaden a nonprofit’s donor base, potentially attracting younger, tech-savvy donors. One organization, Bitcoin100, pledges to donate “the Bitcoin equivalent of $1000 to non-political, secular charities that prominently display an option for supporters to contribute via Bitcoin on their website.”[3]
Prior to receiving such a contribution, a nonprofit would need to set up its own virtual wallet or account. A donor can then enter the nonprofit’s Bitcoin address, the payment amount, and press “send.” Most wallets permit a donor to obtain a donee’s address by scanning a QR code or touching two phones together with NFC technology.
As personal property, tax consequences to the donor could vary depending on whether the donor holds the Bitcoin as a capital or non-capital asset, as discussed above. Donors contemplating making a contribution of Bitcoin should consult with a tax professional to determine the amount he or she should deduct.
Depending on the size of the Bitcoin donation, the donor may have additional reporting obligations. If the donation is greater than $500, the donor must complete Form 8283 “Noncash Charitable Contributions” and attach it to his or her individual tax return. If the nonprofit sells the Bitcoin within three years of the donation date, it must complete Form 8282 “Donee Information Return” and provide a copy to the donor.
If the Bitcoin donation is greater than $5,000, the donor must determine whether an appraisal is necessary. An appraisal is required for most donations of personal property, but an exception is made for publicly-traded stock having market quotations that are readily available. Bitcoin has characteristics of publicly-traded stock, but it does not fit neatly into this exception to the appraisal requirement. After making a donation of Bitcoin, the donor will receive a receipt which contains a time stamp. The time stamp can be compared against historical markets to determine the actual value of the donation at any point in time.
In conclusion, it’s not necessary to understand the technology behind Bitcoin to understand the implications for a nonprofit organization. A contribution of Bitcoin is a contribution of property, which can be converted to cash. A donor wishing to make a contribution of Bitcoin to your organization should be welcomed with open arms.
This article is provided for general information and should not be relied upon as legal advice for a specific situation. If you are in need of specific advice or legal representation, please do not hesitate to contact us.
©2014 Bea & VandenBerk
[1] See IRS Notice 2014-21 at http://www.irs.gov/pub/irs-drop/n-14-21.pdf
[2] Christopher Rajotte, Andrew Ittleman, and Mitchell Fuerst, Bitcoin Taxation: Understanding IRS Notice 2014-21, Bitcoin Magazine (Apr. 4, 2014), http://bitcoinmagazine.com/11942/bitcoin-tax-understanding-irs-notice-2014-21/.
[3] See http://bitcoin100.org/ for more details.