This article was originally published on Sound Advisory here.
What is a donor-advised fund?
A donor-advised fund (DAF) is a highly flexible charitable giving tool that allows you to make a charitable contribution, receive an immediate tax deduction, and then recommend grants from the fund over time. Think of it as a “lily pad” that provides a strategic resting place for your charitable assets before they reach their final destination.
Imagine a frog perched on the bank of a stream, ready to jump across. This frog represents your bitcoins, and the stream is the path to charitable giving. The lily pad in the middle of the stream is the donor-advised fund (DAF), a powerful tool to maximize your charitable impact while enjoying significant tax benefits. Let’s explore how this leap can be rewarding and transformative.
The Jumps: Giving Away Appreciated Bitcoins
You bought bitcoins for $5,000 and they are now worth $70,000, representing a gain of $65,000. By gifting these appreciated bitcoins to a DAF, you can avoid capital gains taxes on the appreciation. Here's how the process works:
1. The initial leap: getting the deduction
The frog (your bitcoin) jumps from your personal holdings to the lily pad (the DAF). This jump allows you to claim a gift tax deduction for the full fair market value of the bitcoin at the time of the gift—in this case, $70,000.
2. On the lily pad: waiting to distribute
While your bitcoins remain in the lily pad, you have the flexibility to redesign your donation strategy. You can continue to hold bitcoins, convert some or all of them into cash, or diversify them into other investments. This period in the lily pad is crucial to align your donation strategy with your financial goals.
3. The final leap: donations to charities
Finally, the frog makes its final leap to the other side of the stream: the chosen charities, which can include hospitals, schools, religious organizations, and even non-profits dedicated to Bitcoin development. The beauty of the DAF is that the recipient charities can receive either assets or cash, simplifying their operations. They do not need to set up any new Bitcoin infrastructure to receive donations that originated as Bitcoin.
Applications
Donor-advised funds offer several practical applications:
Simplifying donations
Charities can receive cash donations, making it easier for them to manage funds without having to deal with the complexities of holding and converting bitcoins. Meanwhile, donors enjoy the tax advantages of gifting appreciated bitcoins and can choose how long the bitcoins are held before final conversion and granting.
Clean up alternative currencies
Donor-advised funds can support donors with diverse cryptocurrency portfolios. Donors can gift altcoins, such as Ethereum or others, to the DAF, sell them tax-free, and repurpose the proceeds into bitcoin or other assets, consistent with their investment and charitable goals.
Strategic tax planning
The DAF is a tool that can be combined with many other tools. The first step toward the platform offers the opportunity to combine it with other tax strategies, such as Roth conversions or the sale of a business. This approach can create a multiplier effect, improving the overall tax efficiency of the donor's financial plan. In effect, a donor can schedule large write-offs to offset other income and focus their charitable giving up front.
Gift and replacement
You may have heard of the idea of “spend and replace”: you can spend your bitcoins and buy back the same amount to maintain your net bitcoin position. The “gift and replace” concept applies to charitable donations, suggesting that giving away appreciated bitcoins and buying them back can be more effective than simply giving cash. By doing this, you increase the overall basis of your position. Rather than giving cash, gifting bitcoins with a low basis and then buying it back allows you to reset your cost basis to the current market value, potentially benefiting your financial situation by reducing future capital gains taxes.
Innovative approaches: donor-advised funds in chain
Good advice, UI Charity Advisorsand Unchained have pioneered the first of its kind: an on-chain donor-advised fund (DAF). This innovative solution uses a multi-signature setup to hold Bitcoin on-chain, ensuring unparalleled security and transparency. In this 2-of-3 multi-signature agreement, the client, University Impact, and Unchained each hold a key. This structure allows clients to verify that their Bitcoin remains secure on-chain while waiting to be distributed to their chosen causes.
To our knowledge, there is no other structure like this, where a customer can hold a key and confirm the status of their bitcoins on-chain. This setup gives customers peace of mind that their charitable contributions are secure and transparent, setting a new standard in donor-advised fund management.
Conclusion
The metaphor of the bitcoin frog jumping across the DAF lily pad to get to the other charitable side illustrates the strategic benefits of channeling your bitcoins through a donor-advised fund. From the initial jump (tax deduction) to the flexible period in the lily pad (strategic planning) and finally the impactful jump to your chosen charities, the process is designed to maximize both your charitable impact and your financial benefits. Whether you’re simplifying giving, cleaning up altcoin positions, or integrating with other tax strategies, donor-advised funds provide a versatile and powerful tool for philanthropy.
By incorporating bitcoin into your charitable giving strategy, you can make a significant impact while enjoying significant tax benefits. So take the leap, let your bitcoins climb the lily pad, and watch them transform into a force for good. Fix money. Fix the world. Go for it!
This is a guest post by Jessy Gilger of Sound Advisory. The views expressed are solely his own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.
