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 poised on the bank of a stream, ready to leap to the other side. This frog represents your bitcoin, 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 for maximizing your charitable impact while enjoying significant tax benefits. Let’s explore how this leap can be both rewarding and transformative.
The Leaps: Gifting Appreciated Bitcoin
You purchased bitcoin for $5,000, and now it’s worth $70,000—a $65,000 gain. By gifting this appreciated bitcoin to a DAF, you can avoid capital gains taxes on the appreciation. Here’s how the process unfolds:
1. The Initial Hop: Getting the deduction
The frog (your bitcoin) leaps from your personal holdings onto the lily pad (the DAF). This leap allows you to claim a charitable tax deduction for the full fair market value of the Bitcoin at the time of the donation, in this case, $70,000.
2. On the Lily Pad: Waiting to distribute
While your bitcoin rests on the lily pad, you have the flexibility to redesign your charitable strategy. You can continue holding the bitcoin, convert some or all of it into cash, or diversify into other investments. This period on the lily pad is crucial for aligning your giving strategy with your financial goals.
3. The Final Leap: Gifting to charity
Eventually, the frog makes its final leap to the other side of the stream—your chosen charities. These could include hospitals, schools, religious organizations, and even bitcoin development non-profits. The beauty of the DAF is that the recipient charities can receive assets or cash, simplifying their operations. They do not need to set up any new bitcoin infrastructure to receive gifts that originated as bitcoin.
Applications
Donor-advised funds offer several applications in practice:
Simplifying Donations
Charities can receive cash donations, making it easier for them to manage funds without dealing with the complexities of holding and converting bitcoin. Meanwhile, donors enjoy the tax advantages of gifting appreciated bitcoin and can choose how long the bitcoin is held before the final conversion and grant.
Alternative Coin Cleanup
Donor-advised funds can help donors with diverse crypto portfolios. Donors can gift alternative coins, like Ethereum or others, to the DAF, sell them tax-free, and redeploy the proceeds into bitcoin or other assets, aligning with their investment and charitable goals.
Strategic Tax Planning
The DAF is a tool in the belt that can be combined with many other tools. The initial hop onto the lily pad provides an opportunity to combine with other tax strategies, such as Roth conversions or selling a business. This approach can create a multiplier effect, enhancing the overall tax efficiency of the donor’s financial plan. Effectively, a donor can time large write-offs to offset other income and front-load their charitable gifting.
Gift and Replace
You may have heard of the “spend and replace” idea: you can spend your bitcoin and buy the same amount back to maintain your net bitcoin position. The “gift and replace” concept applies this to charitable giving, suggesting that gifting appreciated bitcoin and buying it back can be more effective than just giving cash. By doing this, you increase the overall basis of your position. Rather than giving cash, gifting bitcoin with a low basis and then repurchasing it 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: On-Chain Donor-Advised Funds
Sound Advisory, UI Charitable Advisors, and Unchained have pioneered the first of its kind: on-chain donor-advised fund (DAF). This innovative solution uses a multisignature setup to maintain bitcoin on-chain, ensuring unparalleled security and transparency. In this 2-of-3 multisig arrangement, the client, University Impact, and Unchained each hold a key. This structure allows clients to verify that their bitcoin remains securely on-chain while waiting to be distributed to their chosen causes.
To our knowledge, no other structure exists like this, where a client can hold a key and confirm their bitcoin’s on-chain status. This setup provides clients with peace of mind, knowing that their charitable contributions are both secure and transparent, setting a new standard in the management of donor-advised funds.
Conclusion
The metaphor of the bitcoin frog hopping across the DAF lilypad to get to the charitable other side illustrates the strategic benefits of channeling your bitcoin through a donor-advised fund. From the initial leap (tax deduction) to the flexible period on the lily pad (strategic planning) and finally, to the impactful leap to your chosen charities, the process is designed to maximize both your charitable impact and your financial benefits. Whether you’re simplifying donations, cleaning up alternative coin 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 substantial tax benefits. So, take the leap, let your bitcoin hop onto the lily pad, and watch it transform into a force for good. Fix the money. Fix the world. Hop to it!
This is a guest post by Jessy Gilger from Sound Advisory. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.
