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Estate Planning for Cryptocurrency
February 1, 2022
Digital currencies (or cryptocurrencies) such as bitcoin are not just a fad. They are resources with potentially significant value, which is why the IRS is increasingly focusing enforcement efforts on collecting data in this area.
In 2014, the IRS ruled that cryptocurrency is “property” rather than currency. Accordingly, cryptocurrency is subject to capital gains tax rules. The fair market value of cryptocurrency is to be calculated “by converting the virtual currency into U.S. dollars . . . at the exchange rate, in a reasonable manner that is consistently applied.” There are sources that keep historical records of the value of a cryptocurrency as of a certain date, such as Poloniex and Coinmarketcap.com. These resources enable users to access cryptocurrency records much as they can access historical records of stock.
Cryptocurrency owners need to keep detailed records of the date of each virtual currency purchase and the amount, so that capital gains tax planning can be accomplished effectively, such as (1) selling and paying the tax (or taking a loss) now, (2) gifting with a carry-over basis, or (3) allowing it to pass at death to give the beneficiary a stepped-up basis.
Digital currencies have value, and so when someone dies owning cryptocurrency, it must be reported in the valuation of an estate.
If the cryptocurrency is stored in a software wallet not connected to an exchange, arrangements should be made to protect and then transfer the private key or seed phrase for unlocking access to the person who will own the virtual currency after the owner’s death. Storing the key or phrase in a safe-deposit box is a frequently used technique. If the owner has cryptocurrency stored on an exchange, then protection, storage, and transfer of the username, password, and security question information are needed. In addition, some exchanges use two-factor authentication. For example, after entering the username and password on the exchange’s website log-in page, the exchange may send a numerical code to the owner’s cell phone, which the user must then enter to access the owner’s account. If this is the case, the cell phone itself and how to access it also must be protected for the beneficiary.
If someone owns cryptocurrency stored on a hardware wallet (flash drive), arrangements to reveal to the intended beneficiary both the drive’s location and the keys, phrases, or codes needed to access it must be made. As with software wallets, keeping the device and phrase in a safe-deposit box is often an effective protection method.
Will there be a specific gift of any cryptocurrency upon death (either to a person or to a trust) or will the cryptocurrency become part of the decedent’s general estate? If a specific gift is intended, the gift provision needs to be drafted carefully so as to transfer the cryptocurrency but not contain the private key, seed phrase, password, or other access information. Instead, the will should describe how the beneficiary (or trustee, if the transfer is to a trust) may obtain this information.
After a person has died, the executor of the estate will need to search diligently for the existence of digital currency. If the decedent used an exchange to purchase the cryptocurrency, the exchange account typically will be linked to a bank account or credit card, so the decedent’s bank records or emails may provide a clue that the account exists. Signs of cryptocurrency also can be spotted on the decedent’s phone, tablet, or computer, if a mobile wallet or offline wallet were used.
If cryptocurrency is located, the executor or administrator will need to deal with it appropriately. The property is just like any other estate asset. It needs to be preserved as much as possible if it is subject to a specific bequest in the decedent’s will. If it is not, the personal representative will need to decide whether to retain the cryptocurrency or liquidate it for United States currency. This will require the executor or administrator to act as a reasonably prudent investor.
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