Matthew Costa, CPA, CFP® MAcc
As all of us paying attention to the recent tax reform suspected that:
1. We will not be doing our taxes on a postcard going forward, and
2. The US treasury would not just forget about the wealth that has been created in the cryptocurrency space in 2017.
Washington lawmakers and influencers are paying increased attention to the new, innovative, and disruptive market of crypto assets. Amidst the meteoric rise of cryptocurrencies in the fourth quarter of 2017, tax reform decisively closed off a much hoped for tax planning strategy for cryptocurrency users. In 2014, the IRS issued Notice 2014-21, clarifying that cryptocurrency is treated as property for tax purposes. Although, the IRS did not address IRC §1031 in that notice, many users believed that, as property, exchanges of differing types of cryptocurrency could qualify for IRC §1031 like-kind exchange deferral. However, this “loophole” has recently been closed in no uncertain terms. Pursuant to the Tax Cuts and Jobs Act, enacted December 22, 2017, IRC §1031 like-kind exchange treatment is now specifically limited to real property.
Despite the 30-40% correction downward in January 2018, many multi-millionaires have been created in the last few months. Significantly, some of the recent wealth that has been created has a more altruistic hue to it than has typically be seen in the long history of trade. The revenge of the tech savvy nerds is upon us! Some crypto assets try to bring banking to the forgotten third world, some tokens are interested in preventing fraud in airline shipping and human trafficking, and some new tokens are designed to save energy. Looking at the space as a whole, there are a lot of developers and investors looking to change the world for the better.
With increasing IRS scrutiny, how can these new millionaires mitigate and defer tax dollars while diversifying their assets away from being so heavily weighted in one sector like crypto assets?
A Charitable Remainder Unit Trust (CRUT)
A taxpayer donates highly appreciated assets (in this case cryptocurrency) into a CRUT and then immediately sells the assets with the intent to create a diversified portfolio of income producing assets. The sale of the cryptocurrency by the CRUT does not cause an immediately taxable event to the trust or the non-charitable beneficiaries of the trust. The proceeds of the sale remain in the trust and may be reinvested in other assets. The trust distributes a fixed percentage of the value of its assets to a non-charitable beneficiary or beneficiaries of the taxpayer’s choosing. At the death of the last named non-charitable beneficiary, the remaining balance is distributed to the charity or charities identified in the trust. Provided the present value of the remainder interest going to the charity is greater than 10% of the contribution, that present value of the charitable remainder interest qualifies as a current tax deductible charitable donation.
Example: A 40-year-old taxpayer contributes $1,000,000 of Bitcoin to a trust and assigns a 7% payout rate with themselves as the income beneficiary. Using the IRS discount rates and tables, the present value of the remainder interest going to the charity at death would be roughly $101,000, satisfying the 10% test. Regardless of what the taxpayers’ basis, he or she gets a $101,000 current income tax deduction and also receives 7% of the fair market value of the trust distributed annually until death. For instance, if the market value of the trust is $1,000,000 in given year, then the distribution to the beneficiary is $70,000.
As the payout percentage goes down the present value of the charitable donation would increase. For instance, a 5% payout percentage to the income beneficiary would yield a present value closer to $177,000.
A summary of the benefits are as follows:
1. The trust is irrevocable and the assets are not included in the estate of the donor.
2. Taxpayer donor can contribute highly appreciated assets and forego immediately paying tax on the appreciation.
3. Current income from the trust goes to a non-charity beneficiary of the donor’s choosing (can be the donor themselves).
4. The balance of the trust is distributed to the charity at the death of the last remaining non-charitable beneficiary.
5. The donor is entitled to a charitable donation income tax deduction at the present value of the remainder interest in the CRUT.
6. Diversification away from crypto-currency asset to income producing assets is achieved.
Charitable Lead Trusts (CLT)
CLTs should not be overlooked. In a CLT, the income produced by the donated assets goes to a charity, but after a specified period of time the remainder goes to a beneficiary of the donor’s choosing. Given the current interest rate environment, a CLT may be perfect for those with other forms of wealth that can sustain a lifestyle while waiting for funds to be returned to their use.
Another option for highly appreciated assets is a Donor-Advised Fund. This is a charitable giving vehicle that is administered by a public charity to manage donations. The donor surrenders ownership of the property but retains advisory privileges over how the account is invested and distributed to charities. Please note that the donor has no income stream with this arrangement and should only be considered for those with the means and charitable intent this option necessitates.
Charitable vehicles offering lifetime income streams, current charitable tax deductions in excess of basis, and diversification of a portfolio heavily weighted in cryptocurrencies are extremely effective planning tools. Careful assessment of a taxpayer’s financial and charitable goals, will determine the most suitable vehicle for that taxpayer’s needs.
Frost & Associates, LLC in partnership with RCN & Associates, LLC will be performing a seminar on cryptocurrency tax planning strategies on March 7th 2018 at 6pm. This event is being held at 888 Bestgate Road, Suite 400, in Annapolis, MD 21401 (located on the 4th floor). Please click here to RSVP if you are interested in attending.