Once dismissed as a worthless and risky venture, cryptocurrency has exploded in popularity in recent years. But despite surging usage, some areas of cryptocurrency, such as tax policy, still elicit confusion. And in the haze of cryptocurrency investing and trading, estate and financial planning are overlooked, leading to lost investments and, ultimately, time wasted.
Due to cryptocurrency’s volatility, buying and trading takes time and dedication. Therefore, the last thing anyone wants is to squander hard work with an avoidable oversight in planning. Essentially, cryptocurrency should be treated like any other traditional asset, and as such, should be accounted for when estate planning.
Cryptocurrency continues to gain steam, and the expert consensus is that the trend is here to stay. In just a short time, the price of Bitcoin has skyrocketed from below a cent in 2010 to a record high of $63,000 in 2021. The technology has become so popular that the U.S. Congress is currently in talks about digitizing the dollar.
Given that cryptocurrency is not going away any time soon, it’s time we start including it in our estate plans.
What is Cryptocurrency?
Cryptocurrency is a digital currency secured by cryptography, a method of preventing counterfeit transactions and double-spending. Popular examples of cryptocurrency include Bitcoin, Litecoin, and Ethereum.
Most cryptocurrency runs on a decentralized network using blockchain technology, whereby information is stored in ledgers distributed across various networks, making it almost impossible to alter or hack. As a central authority like a bank almost never issues cryptocurrencies, they are virtually immune to government interference.
Cryptocurrency is stored in what’s known as a digital “wallet.” This wallet contains a user’s public and private keys and is used to send and receive cryptocurrency. Although a wallet is the only method of storing crypto, different types of wallets exist, including online accounts, mobile apps, and external hard drives. As only the investor should have access to their cryptocurrency wallet, it can complicate estate planning.
Including Cryptocurrency in Your Estate Planning Documents
Much like cash, cryptocurrency is not a traceable asset. Cryptocurrency transactions don’t come with statements, so you’ll need to keep a record of each one for tax and estate planning purposes. Including special provisions for cryptocurrency in your estate planning documents is essential to ensure your assets are not lost upon death.
Please make sure you explicitly refer to your cryptocurrency in your will or a Trust to ensure the executor of your estate is aware of its existence. Failing to mention cryptocurrency in your Will can lead to it being forgotten or inaccessible to intended beneficiaries.
It’s crucial to inform beneficiaries of the value of cryptocurrency, as it can be a difficult concept to grasp for those unfamiliar with it. Failure to properly inform beneficiaries can lead to them neglecting the assets. In some cases, hard drives containing thousands of dollars worth of cryptocurrency have been unwittingly discarded.
Beneficiaries need information on where cryptocurrency is stored and how to access it. You will need to provide them with keys and passcodes to access your digital wallet. Be wary of including keys and passcodes directly in your will, as the information becomes a public record after passing through the probate process.
Cryptocurrency is incredibly secure, so the last thing you’d want to do is undermine that security by listing your passwords in the public domain. Given that cryptocurrency is not government regulated, any losses due to scams or security breaches are not recoverable.
To keep information safe, testators can give keys and passcodes directly to estate executors and trustees or include them in a memorandum to their will.
Tax Implications When Estate Planning with Cryptocurrency
Although cryptocurrencies have existed for over ten years, confusion and misconceptions still exist surrounding how it is taxed and how to dispose of it after a holder’s death. The Internal Revenue Service (IRS) addresses this issue directly in Notice 2014-21, declaring that cryptocurrency is considered property and not currency. This means that general property tax principles, including capital gains taxes, apply to cryptocurrency.
Exactly how the cryptocurrency is taxed will depend on how gains and losses are made. Although cryptocurrency is considered property, it is not taxable as a gift unless its value exceeds $15,000.
Tax implications vary based on whether cryptocurrency is:
- Sold, including for cash
- Traded for another crypto
- Used to purchase goods and services
For example, if you buy cryptocurrency from a third party or mine it yourself and subsequently sell it at a profit, your profits are subject to capital gains taxes. Similarly, if you purchase goods and services using cryptocurrency from your digital wallet, you are liable for capital gains taxes.
Formerly, many cryptocurrency traders avoided including transactions in their tax declarations due to sheer confusion or attempts to evade taxes. Now, this is nearly impossible. Since 2019, the IRS has included a question in Form 1040 requiring taxpayers to declare any cryptocurrency transactions they made during a tax year. For this purpose, it’s imperative to maintain a detailed record of transactions to avoid any missed taxes and subsequent headaches for those left to handle your estate.
Remember that your documents need to reflect the change in your portfolio and in your assets. Do not leave it to chance, review your documents every few years. Contact our office for a consultation if you have recently purchased cryptocurrency and want to update your documents.
Katya Sverdlov, CFA, Esq.
Sverdlov Law PLLC
30 Wall Street, 8th Floor
New York NY 10005
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