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.
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