Increasingly, investors are incorporating cryptocurrencies into their portfolios. Cryptocurrency
has graduated from the fringes of the dark web, where it resided for most of the last decade, to gain acceptance by mainstream institutions and investors. In February, Superbowl LVI featured three advertisements for cryptocurrency companies, one of which generated so much traffic that it crashed the company’s website. Considering the widespread adoption of cryptocurrency and the tax benefits of in-kind charitable contributions of appreciated property, charitable organizations should expect to see an increased number of donors seeking to make in-kind donations of cryptocurrency.

Donors of property are entitled to a charitable deduction equal to the appreciated fair market
value of such property at the time of the transfer —so long as the property has been held for more than one year¹. At the same time, it is well established that unrealized gains are generally not recognized when a donor makes an in-kind transfer for no consideration². The meteoric rise in the use of cryptocurrency in the last year presents an opportunity for charitably inclined taxpayers to maximize this double tax benefit. In some cases, donors have almost no basis in their cryptocurrency holdings, putting the after-tax value of nonrecognition on equal footing with the charitable deduction.

While current economic conditions present a unique fundraising opportunity for charitable organizations to solicit cryptocurrency donations, the opportunity carries compliance risk requiring careful consideration and planning.

The Uniform Prudent Management of
Institutional Funds Act

The Uniform Prudent Management of Institutional Funds Act (the “Act”) has been enacted in 49 states, the District of Columbia, and the U.S. Virgin Islands. The only state that has not adopted the Act is Pennsylvania, which imposes substantially similar requirements through its own law. In making
investment decisions for endowment funds, the Act requires the charitable organization to (1) act in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances (the “prudence standard”),³ and (2) consider its charitable purposes and the purposes of the endowment⁴.

The Act sets forth eight factors to guide investment decisions, which require the charitable organization to consider:

• general economic conditions

• the possible effect of inflation or deflation

• the expected tax consequences, if any, of investment decisions or strategies

• the role each investment or course of action plays within the overall investment portfolio of the fund

• the expected total return from income and the appreciation of investments other resources of the organization

• the needs of the organization and the fund to make distributions and to preserve capital, and

• an asset’s special relationship or special value, if any, to the organization’s charitable purposes⁵.

The Act specifically permits charitable organizations to invest in any kind of property or type of investment consistent with its terms.⁶ There is no reason to believe that this blanket permission excludes cryptocurrency, but the prudence standard—guided by the factors listed above—will likely preclude a charitable organization from allocating sizable portions of its endowed funds to
most cryptocurrencies due to their inherent volatility.⁷ Investment decisions about individual assets are not made in isolation but rather in the context of the portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the endowment and the charitable organization.⁸ Additionally, a charitable organization is required to diversify its
portfolio unless special circumstances dictate otherwise.⁹ Accordingly, cryptocurrency may find a home as a small allocation within a diversified portfolio.

The big caveat to the requirements above is that they are all subject to the donor’s expression of contrary intent.¹⁰ While the emphasis on donor intent does not mean that the donor can or should control the management of the charitable organization, the drafters’ comments to the Act provide that a charitable organization has an overarching duty to comply with donor intent, which is primary to the charitable purposes of the organization or endowment.¹¹ Accordingly, if the donor of a gift instructs the charitable organization to invest the gift in cryptocurrency by the gift instrument, the organization will not fall out of compliance with the Act by abiding by the donor’s instructions.

As mentioned previously, charitable organizations are likely to see an increased prevalence of in-kind donations of cryptocurrency by tax-motivated donors. An organization that accepts such a donation must then decide whether to retain the cryptocurrency or dispose of it. The Act
requires that an organization make and carry out decisions concerning the retention or disposition of property or to rebalance a portfolio to bring it into compliance with the purposes, terms, and distribution requirements of the organization as necessary to meet other circumstances and the requirements of the Act.¹²

While an organization that accepts such a donation will generally prefer to liquidate cryptocurrency immediately upon receipt to raise cash for their charitable purposes or convert it to a more suitable investment, the donor may prefer the organization to retain the cryptocurrency for a period or
indefinitely. If the donor fails to express this intent in the gift instrument, the organization will have to decide whether it will retain the cryptocurrency at the expense of its organizational goals or dispose of the property and jeopardize the likelihood of receiving gifts from the donor in the future.

Notably, the Act does not require the organization to arrive at a particular outcome – the organization may consider a variety of factors in deciding whether to retain or dispose of the cryptocurrency, and a decision to retain it for a period or indefinitely may be a prudent decision.¹³ The drafters’ comments to the Act explain that the potential for developing additional contributions by retaining property contributed to the organization is among the “other circumstances” that the organization may consider in deciding whether to retain or dispose of the property. Accordingly, the organization might be able to justify the retention of a position in a cryptocurrency that is otherwise unsuitable for its investment portfolio on the grounds that the donor i a prospect for future donations. While the organization will likely be able to justify retention with documented discussion and analysis, this gray area is an uncomfortable place to be.

Federal tax reporting obligations

If the donor is claiming a tax deduction of more than $5,000 with respect to a charitable contribution of cryptocurrency, the donee organization is generally required to sign
the donor’s Form 8283, if requested, to substantiate the deduction. The signature of the donee organization does not represent agreement with the appraised value of the cryptocurrency but merely acknowledges its receipt and that the organization understands its own reporting obligations if the cryptocurrency is disposed of within three years of receipt.¹⁴ If the organization disposes of the donated cryptocurrency within the three-year window, it must file Form 8282 to report information about the disposition to the IRS and provide a copy of the form to the original donor.

Remaining compliant through adequate risk management

Charitable organizations must be deliberate in their compliance efforts, establishing robust risk management procedures setting forth detailed instructions for organizational personnel to follow whenever cryptocurrency comes through the door. Risk management procedures may be
different for each organization but should include common-sense measures such as requiring any
donor making an in-kind gift of cryptocurrency or establishing a fund to hold cryptocurrency to sign an approved gift instrument stating, in no uncertain terms, the donor’s intent for the gift; requiring any donation of cryptocurrency with a value exceeding $5,000 to be disposed of only with the approval of a specific individual responsible for federal tax reporting; and requiring that any purchase of cryptocurrency be accompanied by documentation of the discussion and analysis justifying the purchase.

Read the full Spring issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.

1 Treas. Reg. § 1.170A-1(c)(1).

2 The Humacid Co. v. Comm’r, 42 T.C. 894, 913 (1964).

3 UPMIFA § 3(b).

4 UPMIFA § 3(a).

5 UPMIFA § 3(e)(1).

6 UPMIFA § 3(e)(3).

7 Notwithstanding this observation, it is noted that one of the
largest charities in the country, the Silicon Valley Community
Foundation, is reported to hold $4.5B in digital assets according
to its financial statement, accounting for nearly a third of its
total investments.
https://www.siliconvalleycf.org/sites/default/files/documents/
financial/2017-independent-auditors-report.pdf

8 UPMIFA § 3(e)(2).

9 UPMIFA § 3(e)(4).

10 UPMIFA § 3(a).

11 See drafters’ comment on UPMIFA § 3 and 3(a): “In addition,
subsection (a) of Section 3 reminds the decision-maker that
the intent of a donor expressed in a gift instrument will control
decision making. Further, the decision-maker must consider the
charitable purposes of the institution and the purposes of the
institutional fund for which decisions are being made.”

12 UPMIFA § 3(e)(5).

13 See drafters’ comment on UPMIFA § 3(e)(5).

14 IRC § 6050L(a)(1)-(2). The exception for publicly traded
securities does not apply because cryptocurrency does not
qualify as a “security” for this purpose. See IRS Frequently
Asked Questions on Virtual Currency.

The GAAP requirement for the reporting of gifts in-kind has been in existence for a number of years. In June 2018, the Board issued Accounting Standards Update No. 2018-08, Not-for-Profit Entities (Topic 958): Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made. This Standard focused predominately on the revenue recognition of donations in-kind and with a heightened focus on donated services rather than all nonfinancial assets. The presentation and disclosure of contributed nonfinancial assets differed greatly among nonprofit entities.

To help supplement its cash resources, many nonprofit entities rely heavily on donors for contributions, which can be classified as either financial or in-kind, i.e., nonfinancial assets. Financial contributions are commonly received in the form of grants, pledges, or donations and are received by the organization through a transfer of monetary funds from the donor. In-kind contributions are nonfinancial assets, including goods or services received at no cost or below market cost. Nonfinancial assets include tangible items such as food, clothing, medical or other supplies, furniture and intangible items such as services, voluntary labor, or facilities.

Some of the most frequently overlooked gifts in kind include contributions of advertising time, technical services, use of facilities, costs associated with fundraising events, collection items, car donations, and borrowings at below market interest rates.

In-kind services are only recorded on the organization’s financial statements if they meet specified criteria as determined by Generally Accepted Accounting Principles (GAAP), which requires services contributed in-kind must be performed by professionals and tradesmen with a specialized skill in the service. In-kind contributors are typically accountants, architects, carpenters, doctors, electricians, awyers, nurses, plumbers, teachers, and other professionals and tradesmen. When analyzing these types of services, the organization needs to focus on the notion of “specialized skills” GAAP also requires that contributed services create or enhance a nonfinancial asset belonging to the organization and that it would otherwise have to purchase the service. For example, an electrician donating his services during a construction project at a cost below market or for no cost. Under GAAP, the service would qualify as an in-kind contribution as the electrician has a specialized skill that the nonprofit would otherwise have to purchase. The organization would record the receipt of these services in the “statement of activities” with an offsetting expense or capital assets addition, as explained below.

There is a common misconception among nonprofits that because in-kind donations are provided at little or no cost, the organization doesn’t have to report them on its financial statements. Stakeholders and other readers of the financial statements might dispute that recording these items will merely gross-up revenue and expenses with no effect on the operating results. But conversely, not recording these items can distort an NFP’s financial statements, understating the organization’s revenue and expenses, and does not allow for true comparison between similar organizations. As such, nonprofits are required to report these contributions.

GAAP requires the organization to report the donated items or services meeting the criteria for in-kind donations as revenue in the operating section of the organization’s “statement of activities” on the date the contribution is made known to the organization, regardless of the date on which the item or service is received. As explained in FASB ASC 958-605, the donated nonfinancial assets must be reported at fair market value, defined by ASC topic 820 as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” As well, GAAP requires an offsetting expense in the proper natural expense category on the organization’s “statement of functional expenses,” also reported at the determined fair market value as described in ASC topic 820. Suppose the item or service is an asset that exceeds the organization’s capitalization policy, like the electrician cited above. In that case, the asset is recorded in the proper fixed asset category on the “statement of financial position,” and revenue is recognized for the asset’s fair market value. Determining the fair value to be recorded is often the most challenging part of the accounting exercise.

FASB Accounting Update

Based on stakeholder feedback, the FASB issued this update to increase transparency through enhanced financial statement presentation and disclosure of nonfinancial assets. However, the revenue recognition and measurement requirements for these nonfinancial assets remain unchanged in ASC 958-605.

FASB Accounting Standards Update (ASU) No. 2020-07, Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets, are effective for nonprofits with annual periods beginning after June 15, 2021, and interim periods within annual periods beginning after June 15, 2022. Early adoption of the standard is permitted by nonprofits. Retrospective transition is required. So any periods reported upon must comply with the updated standard. The enhanced presentation and disclosure requirements are:

• The contributed nonfinancial assets are stated separately from other contributions in the statement of activities.
• A footnote disclosure must be made to disaggregate the contributed nonfinancial assets by type such as food, medical supplies, fixed assets, facility usage, services, to name a few.
• The NFP’s policy (if any) on liquidating rather than using contributed nonfinancial assets for each type of nonfinancial asset identified.
• Qualitative considerations to be disclosed include:

  -Whether the contributed nonfinancial assets were liquidated.

  -A description of any restrictions requested at the time of contribution by the donors.

  -A description of the technique the organization uses to arrive at the fair value measurement of the nonfinancial asset in accordance with paragraph 820-10-50- 2(bbb)(1), at the time the asset is initially recorded.

  -The principal market used to arrive at the fair value measurement (The principal market is the market with the greatest volume of activity that the organization is legally able to access in order to value the asset.)

Under the new standard, when an organization receives donated services it must disclose the services received during the financial statement period, including the revenue recorded on the statement of activities and the programs or activities the services were used for. The organization is required under the new standard to provide disclosure regarding services received in-kind regardless of whether they meet the revenue recognition criteria defined by GAAP; however, the organization is only required to record revenue on the statement of activities if it meets the GAAP criteria. The standard allows for the nature and extent of such services disclosed but not recorded to be described in the footnotes by nonmonetary information, which can include but is not limited to the number of hours received in services or outputs provided by board members or volunteers, such as contributions raised. Many organizations may have donated services that are recorded as contributions and others that are only disclosed in the footnotes.

As the effective date of FASB Accounting Standards Update (ASU) No. 2020-07, Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets draws near, it will be important for nonprofit organizations to closely monitor the receipt of nonfinancial assets and services received as well as their methods of valuing such contributions. HBK Nonprofit Solutions team members will be happy to assist you with these accounting challenges.

Read the full Winter issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.