Qualified appraisals are required for any donation of cryptocurrency exceeding $5,000. The IRS also noted that if a taxpayer failed to obtain an appraisal, they would not qualify for the reasonable cause exception. This creates a significant barrier for crypto investors hoping to donate their assets.
On January 10, 2023, the Office of Chief Counsel Internal Revenue Service released Memorandum 202302012 (CCA 202302012). In the memorandum, the IRS was asked if a taxpayer is required to obtain an appraisal in order to take the deduction for their donation. They were also asked if the reasonable cause exception was applicable if the taxpayer failed to obtain an appraisal:
“Issues
- Is Taxpayer A required to obtain a qualified appraisal under section 170(f)(11)(C) of the Code for contributions of cryptocurrency for which Taxpayer A claims a charitable contribution deduction of more than $5,000?”
- If Taxpayer A is required to obtain a qualified appraisal under section 170(f)(11)(C) of the Code and fails to do so, does the reasonable cause exception provided in section 170(f)(11)(A)(ii)(II) apply if Taxpayer A determines the value of the cryptocurrency based on the value reported by a cryptocurrency exchange on which the cryptocurrency is traded?”
Much to the dismay of crypto investors, the IRS said that a qualified appraisal was in fact required in order to take the deduction. They also clarified that the taxpayer would not qualify for the reasonable cause exception if they failed to get an appraisal:
“Conclusions
- If Taxpayer A donates cryptocurrency for which a charitable contribution deduction of more than $5,000 is claimed, a qualified appraisal is required under section 170(f)(11)(C) to qualify for a deduction under section 170(a)
- If Taxpayer A determines the value of the donated cryptocurrency based on the value reported by a cryptocurrency exchange on which the cryptocurrency is traded rather than by obtaining a qualified appraisal, the reasonable cause exception provided in section 170(f)(11)(A)(ii)(II) will not excuse noncompliance with the qualified appraisal requirement, and Taxpayer A will not be allowed the charitable contribution deduction under section 170(a).”
Appraisal Requirement a Surprise to Crypto Investors
That news, especially the appraisal requirement, was likely a surprise to the majority of crypto investors. An appraisal is not required for seemingly similar assets such as publicly traded securities. In their response, the IRS even notes this:
“A qualified appraisal is not required for donations of certain readily valued property specifically set forth in the Code and regulations, namely: cash, stock in trade, inventory, property primarily held for sale to customers in the ordinary course of business, publicly traded securities, intellectual property, and certain vehicles.”
Appraisals Are Required for Other Assets
It is perfectly understandable why certain assets need to be appraised when being donated (and importantly from the perspective of the IRS, a tax deduction is being claimed). How much is that piece of art worth? Grandma’s diamond necklace? Even non-collectible/personal property items can be subject to attempts to manipulate the value reported to the IRS.
Depending upon whether a taxpayer is paying tax on the value of something (in the case of estate taxes for example) or claiming a deduction for the value of something (as in the case of a donation) people try to game the system. This is why there are antique appraisers, and real estate appraisers, and even business valuation experts. (That latter – placing a value on an operating business is a specialty of our firm and my partner Dave. For purposes of taxes, divorce, estate planning, etc. we provide a professional, expert analysis of the value of an operating business.)
Getting a legitimate, expert opinion on these harder-to-value assets helps to ensure that the IRS is not being hoodwinked and that any deductions claimed are appropriate.
Placing a value on other assets is much simpler and doesn’t require an appraisal. Say for example that someone donates 100 shares of XYZ Co. stock. That stock trades on a regulated exchange and it is a simple matter to determine what the price was on any given day, based on where the stock traded.
And In many respects, the crypto market resembles the stock market. The fair market value of the asset is readily available on exchanges – even though admittedly these exchanges are not as regulated in the stock market, and can be subject in some cases to inexact reporting of actual trading volume. But still, there is a ready marketplace with actual quoted prices.
Memorandum Affects All Crypto Assets
However the IRS is not treating crypto assets in the same way as publicly traded stocks, bonds, and mutual funds. Remember, the memorandum states that an appraisal is required. And that requirement is not exclusive to low-liquidity or thinly traded tokens. It includes the larger, more active crypto assets (Bitcoin, Ethereum, etc.) as well.
In the context of altcoins or newer NFT projects, this IRS memorandum makes perfect sense. In those cases, the potential for abuse is significant and also pretty obvious. For instance, I could theoretically create 1,000 “MicahCoins” or “MicahNFTs”, sell one of them for $100 to a related party, donate the remaining 999 to charity, and then claim a charitable donation deduction of $99,900.
After all, the first one sold for $100. A FMV has been established. And all on a publicly distributed ledger available to a global market. Right? Wrong – for obvious reasons. It would be bogus and manipulated.
You already see variations of this with “rug pull” schemes and scam tokens, so someone attempting to use the same mechanism for tax fraud is not a huge leap. Given this, requiring an appraisal for newer projects makes sense and seems like a reasonable precaution.
But Bitcoin? Ethereum? This is where the ruling becomes a bit of a head-scratcher. Are we really claiming the same potential for valuation abuse exists with major projects? Even in this bear market, crypto’s market cap sits at just over $1 trillion. Bitcoin alone has a market cap of over $400 billion and is traded globally. The dollar volume traded every day is many, many billions of dollars. So this being required for larger assets or projects feels a little counterintuitive.
And the SEC and other governmental agencies are already arguing that at least some cryptocurrencies are simply unregistered securities. So why are they being subjected to such higher standards than stock donations?
Tax Code Provides Specific Exceptions to Appraisal Requirement
Because section 170(f) provides a specific list of exceptions to the qualified appraisal requirement. An appraisal being required is the norm. All other assets require an appraisal in order to take the deduction. And at least for right now, crypto is not classified as a security and thus does not qualify for the exception. The IRS notes that:
“In this case, no exception to the qualified appraisal requirements of section 170(f)(11) applies. Cryptocurrency B is not cash, a publicly traded security, or any other type of property listed in sections 170(f)(11)(A)(ii)(I) and 1.170A-16(d)(2)(i). Accordingly, since Taxpayer A claimed a charitable contribution deduction of over $5,000 for the donated cryptocurrency, a qualified appraisal is required.”
This will likely create a major headache for taxpayers who donate without being aware of this requirement, since that deduction would be disallowed:
“Taxpayer A’s use of a value reported on a cryptocurrency exchange to value the contribution does not satisfy the qualified appraisal requirement or satisfy the reasonable cause exception to that requirement; therefore, Taxpayer A’s deduction must be disallowed.”
Even if a taxpayer is aware of the requirement, this could still prove problematic. Not only will it require the time and expense of obtaining an appraisal, but it is also unclear who would actually be qualified to give an appraisal for crypto assets. Section 170(f)(11)(E) provides the following guidelines as to who is a qualified appraiser:
“(ii) Qualified appraiser
Except as provided in clause (iii), the term “qualified appraiser” means an individual who—
(I) has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements set forth in regulations prescribed by the Secretary,
(II) regularly performs appraisals for which the individual receives compensation, and
(III) meets such other requirements as may be prescribed by the Secretary in regulations or other guidance.
(iii) Specific appraisals
An individual shall not be treated as a qualified appraiser with respect to any specific appraisal unless—
(I) the individual demonstrates verifiable education and experience in valuing the type of property subject to the appraisal, and
(II) the individual has not been prohibited from practicing before the Internal Revenue Service by the Secretary under section 330(c) [2] of title 31, United States Code, at any time during the 3-year period ending on the date of the appraisal.”
Difficulty for Crypto Investors Hoping to Make Donations
Given the relative newness of the cryptocurrency space, it is not abundantly clear who – if anybody – would qualify under these guidelines. There are organizations out there that offer this as a service, but whether or not their education, expertise, and the organization through which they are credentialed are sufficient is still to be determined. It’s easy to envision diploma-mill style certifications that are created, but whose appraisals would not withstand a challenge in court.
As always, make sure you remained attuned to these changes – or at least make sure you are working with CPAs, attorneys, and other advisors who are. Failure to do so could prove to be costly.
Any accounting, business, or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.
