The price of bitcoin has skyrocketed, turning those who bought even just a small amount of the cryptocurrency over the years on a whim into millionaires. Those who want to cash in on their profits can always sell their bitcoin, but the tax consequences of an outright sale can put a big dent in your after-tax gains.

Those bitcoin owners with a more charitable bent have an opportunity to make generous donations while also giving themselves a valuable tax break. Thanks to the way that the IRS treats bitcoin for tax purposes, giving the cryptocurrency to charity can save bitcoin owners a ton of potential tax liability and also provide an equally valuable tax deduction to reduce their overall tax liability.

Red ribbon reading charity, with a hand holding a heart, looked at through a magnifying glass.

Image source: Getty Images.

Why giving bitcoin is smarter than selling it and giving the cash

In the eyes of the IRS, bitcoin is an investment asset, and so selling it leaves investors subject to the rules governing capital gains. When you sell bitcoin, you'll pay capital gains tax on any increase in value since you bought the cryptocurrency. If you've held it for a year or less, then you'll pay short-term capital gains taxes at your ordinary income rate. Those who've held bitcoin for longer than a year will pay long-term capital gains taxes at rates ranging from 0% to 20%, depending on your ordinary income tax bracket.

If you sell your bitcoin and give away the proceeds, then you'll end up paying income tax on the profits. For instance, say you're in the 25% tax bracket and bought a bitcoin for $1 back in 2010. At the moment you're looking at selling it, it's worth $19,001. If you sell the bitcoin, then you'll have a capital gain of $19,000. If you're also in the top tax bracket, then you'll pay a 15% long-term capital gains tax on that gain, costing you $2,850 in taxes. That leaves $16,150 to go to charity, for which you'll get an itemized deduction that could reduce your tax bill by $4,038. At the end of the day, you'll end up with a net tax savings of $1,188, and the charity will get $16,150 in cash.

Now compare that to what happens if you give away the bitcoin. Your donation will be $19,001, for which you'll get a full deduction because you've owned the bitcoin for longer than a year. That will reduce your tax by $4,750. All of that savings will accrue to you because there won't be any tax from selling the bitcoin. When the charity sells the bitcoin to raise cash, it won't owe any tax either because it's a tax-exempt organization. Your net tax savings is roughly four times as large by giving away the bitcoin, and the charity gets more money in the end.

Too good to be true? Not if you follow the rules

This might sound like an incredible deal, but it's a strategy that stock investors have known about for years. Gifts of appreciated stock also qualify for this treatment, and giving away shares can both prevent you from having to pay capital gains tax and give you a larger donation amount than you'd otherwise get.

There are some rules that you'll have to keep in mind:

  • Donations to charity are deductible only if you itemize your deductions. Those who take the standard deduction won't get an additional tax break.
  • A charitable deduction of the full fair market value of bitcoin or any other investment asset is only available if you've held the asset for longer than a year. With property that would be subject to short-term capital gains treatment, you can only deduct your tax basis, which is generally what you paid. In the bitcoin example above, that would mean deducting just a single $1.
  • The amount of your charitable deduction of capital-gain assets is limited to a fixed percentage of your income. For most regular charities, the limit is 30% of adjusted gross income, but for some special tax-exempt institutions like certain private foundations, a lower limit of 20% of income applies.
  • Don't wait until the last minute. With bitcoin, transfer can be relatively quick, but only if your charity has a way to receive the bitcoin. With stocks, the process of going through a broker can take several days, making it much better to get started at least a week in advance -- if not more. Some brokers impose their own deadlines, so check to see if your institution has such a requirement.

Be generous with your successful investments

Whether you've been fortunate to own bitcoin or have other investments that have risen dramatically in value, giving them away to charity can be a great way to reap tax savings while meeting your philanthropic goals. Knowing the tax benefits is crucial in order to structure your gift in the best possible way.