- By Tadd Lindsay
- March 14, 2023
Summary of presentation at the Gift & Estate Tax Committee – ACTEC 2023 Annual Meeting given by Mark Lingerfield and Tadd Lindsay
Background
In December 2022, Coinmarketcap reported that there were approximately 21,910 different cryptocurrencies with a total market capitalization of $850 billion.
Recently, the crypto markets went through what is referred to as a “Crypto Winter”. In May 2022, stablecoin TerraUSD and its sibling coin Luna collapsed. TerraUSD went from $1 to 11 cents and Luna went from $80 to a fraction of a cent. There have been many examples of fraud and scams in the crypto markets, but it is interesting to note that although illicit crypto transactions reached an all-time high in 2022, they represented less than one quarter of one percent of all crypto transactions as reported by Chainanalysis Weekly. Needless to say, cryptocurrencies can fluctuate wildly in value and investors need to do their due diligence before investing in this market.
What are we seeing in cryptocurrency from an appraisers perspective?
MPI has seen an increasing number of appraisal projects that involve cryptocurrency over the past several years. There are three areas where these appraisal projects originate from:
Charitable Giving
This is where we see the largest volume of projects. The typical case that we see would be a client donating cryptocurrency to a donor advised fund or other charitable organization and they need a qualified appraisal to claim a deduction for income tax filing purposes.
Back in 2017, a donor known as the Pineapple Fund donated 5,104 bitcoins worth over $55 million to 60 charities. This is notable in a couple of respects – this donation is considered to be the first real case of a donor using cryptocurrency or the start of “crypto philanthropy”. This case is also notable in that for the majority of the nonprofit recipients, it was their first experience with this type of donation.
Fast forward several years – according to Fidelity Charitable, in 2021 they received around $331 million in crypto donations up from $28 million in 2020. Another nonprofit entity, the Giving Block reported $69 million in crypto donations in 2021, a massive spike of 1,558% from the prior year. The trend is pretty clear in terms of crypto philanthropy growing.
Estates
Over the last few years, we have seen an increasing number of projects whereby an Estate holds cryptocurrency of one form or another and MPI performed a qualified appraisal for estate tax filing purposes.
Intra-family Gifts & Sales of Asset Holding Entities
We are seeing more and more cases whereby a family has made gifts or sales of minority interests in holding company entities such as LPs and LLCs which contain cryptocurrency and require a qualified appraisal for gift tax reporting purposes.
What are the issues that we, as a valuation firm, are faced with in appraising cryptocurrency?
The short answer is that the issues can range from simple to complex depending on the circumstances! As appraisers we need to determine and understand the type of cryptocurrency we are appraising. There are 4 basic types of crypto. These are:
- Payment Cryptocurrencies – most familiar – Bitcoin, Litecoin, Monero – which have a dedicated blockchain.
- Utility Tokens – e.g. Ethereum’s Ether – Tokens are any cryptographic asset that runs on top of another blockchain. To make Tokens even more complex – there are different types of purpose driven tokens such as Service Tokens, Finance Tokens, Governance Tokens, and Media & Entertainment Tokens.
- Stablecoins – e.g. Tether’s USDT – they are designed to provide a store of value. They theoretically maintain their value, because while they are built on a blockchain, this type of cyptocurrency can be exchanged for one or more fiat currencies to which they are pegged such as the US Dollar or the Euro. You may think that by its very name that Stablecoins are “stable” and not volatile. However, Stablecoins are not subject to gov’t regulation or oversight (recall the TerraUSD/Luna example described earlier).
- Central Bank Digital Currencies – or CBDCs are a form of cryptocurrency issued by central banks of various countries. The CBDCs are pegged to the issuing country’s currency. The central banks maintain full authority and regulation over their CBDCs. This form is still in the very early stages. Some countries that have launched CBDCs include; China, India, Nigeria and the Bahamas.
We need to determine the number of exchanges that the subject interest trades on from which to collect pricing data. For example, Bitcoin is priced through a number of sources including the Global Bitcoin Price Index, Coinbase Bitcoin Index, Coinbase Pro, Kraken and Bloomberg’s Virtual Currency Monitor. In the simplest case, an example being a client contributes $100k worth of of bitcoin to the Fidelity Donor Advised Fund, we can review the average of the high and low trading prices (some indexes provide 24-hour pricing averages) quoted on the exchanges and then consider the average of all the pricing indicators to arrive at a fair market value price on the valuation date. IRS Code 25.2512-2(b)(1) provides some guidance on the use of indexes and does not specifically refer to crypto but provides a reference. IRS Notice 2014-21 also provides guidance in Questions 26 and 27 of the Notice: The FMV of cryptocurrency received in a transaction facilitated by a crypto exchange is “the amount the Crypto was trading for on the exchange at the date and time the transaction was recorded on the blockchain ledger”. If not facilitated by an exchange or recorded on a ledger, the IRS allows the use of a crypto or blockchain explorer that analyzes worldwide indices of a particular crypto and calculates the value as of a particular time and day.
We need to determine if the block size of the subject interest being appraised is such that a blockage discount is warranted. This is similar to public stock holding blocks where the block is large as compared to the average daily trading volume and the block could not be liquidated in a short period of time without adversely affecting the market. If subject to blockage discount, we employ well accepted methodologies to determine discounts.
We need to determine if the subject interest being appraised is subject to any restrictions on the ability to sell or liquidate. Restrictions can include such things as smart contracts (computer coded self-executing contracts) resulting in locked tokens (lock-up period with automated unlocking of small blocks of the total over time) or any other contractual restrictions. If there are such restrictions or barriers to liquidity, a hypothetical willing buyer and willing seller of the subject interest would not consider quoted market prices as indicative of the market value. We employ well accepted methodologies to determine the subject interest’s discount from quoted exchange prices in determining the fair market value.
Lastly, another issue worth mentioning is that appraisers must ensure that their appraisal meets the usual standards of IRS appraisal guidelines as well as comporting with various IRS guidance notices and paying attention to any applicable CCA (chief counsel advice) memorandums.
For further reading – Applicable General Guidance & regulations
IRS Notice 2014-21 issued in April 2014– IRS Virtual Currency Guidance – describes how existing general tax principles apply to transactions using cryptocurrency.
IRS Publication 561 – Determining the Value of Donated Property
Applicable Guidance regarding Charitable Donations & Gifts
IRS Section 1.170A-13 – Recordkeeping & Requirements for Deductions of Charitable Contributions
IRS Bulletin 2006-46, Notice 2006-96 – Guidance Regarding Appraisal Requirements for Noncash Charitable Contributions
CCA Memo Number 202302012 dated January 10, 2023 on the subject of Qualified Appraisal Requirement for charitable contributions of cryptocurrency.
CCA Memo Number 202302011 dated January 10, 2023 on the subject of whether taxpayers can claim a deduction for cryptocurrency losses if they still hold the cryptocurrency and have not sold, exchanged or otherwise disposed of it. Issue is claiming loss through abandonment/worthlessness under Code Section 165 for abandoned property.
