The term "Cryptocurrency" refers to digital currency that uses blockchain technology to create a decentralized, immutable, public ledger. Several cryptocurrencies, such as LiteCoin, BitCoin, and Ripple increase in circulation and longevity. Therefore, attorneys who specialize in estate planning are seeing more clients acquiring these assets, which means more clients who want to incorporate them into their estate plans. As interest in them has increased, the IRS has paid more attention to cryptocurrency, but real guidance is still lagging behind.
Crypto Estate Plan Advice is Still Currently Lacking
Because there is currently little authority in the law regarding the tax treatment of cryptocurrency, attorneys should be aware of the specific details about this specialized type of property so as to create the best estate plans for clients who hold cryptocurrency, so as to properly incorporate them into estate plans and so they can administer the estates of deceased clients who owned cryptocurrency at their death.
Though there are more than 1,000 different types of cryptocurrencies, the essential hallmarks of all remain largely the same. Cryptocurrencies are available only in digital form, which means it is necessary to have access to a computer or a smartphone in order to use one. The blockchain is a “digital ledger" that can be shared across a decentralized network of independent computers. That ledger updates and maintains the cryptocurrency in a way that allows anyone to prove the record is complete and uncorrupted. Using this digital ledger, individuals can earn, purchase, and sell cryptocurrency through a network of independent computers that keep track all payments through complex algorithms.
How to Transfer Cryptocurrency
Transfers of cryptocurrency are accomplished through blockchain technology. The transferor enters the transferee’s public address where the transferee will receive the cryptocurrency, along with the transfer amount and an optional note into the digital ledger. Once those pieces of information are entered, the transferor presses “send,” and the decentralized network will validate the transfer. The transferee need not to do anything besides share his public address. Once the transfer is validated, the ledger is updated to reflect that the transfer has been made. No other documentation is required for the transfer to be complete.
Treating cryptocurrency like conventional currency could be troublesome, if it becomes part of an estate plan. The current position of the IRS is to treat cryptocurrency as property and not currency, which means general tax principles applicable to property transactions apply. When creating an estate plan, it is important to consider cryptocurrency as property, in part because the transfer of cryptocurrency can result in losses or gains. The conversion of cryptocurrency into conventional currency may result in a loss or gain. Unlike stocks and bonds, however, cryptocurrency neither pays dividends nor accrues interest. Rather, whether cryptocurrency gains or loses value is much like real estate, in that it’s speculative in nature.
Compared to conventional bank accounts in fiat (traditional) currency, there are few tax or other regulatory reporting requirements for account holders; a fact that has attracted numerous holders. Many have started to use cryptocurrency as a flexible holder of value. For example, cryptocurrency has been used to secure loans because such loans allow cryptocurrency owners to use their asset without “cash out” their cryptocurrency without incurring negative tax consequences.
Cryptocurrency in Estates and Trusts
Some individuals are making gifts of cryptocurrency, as a way to avoid some taxes, including income taxes or estate taxes. Even better, by donating appreciated cryptocurrency to qualified charities, it's possible to receive a charitable deduction on their income tax return for the gift and avoid paying capital gains taxes on the appreciation. In fact, charitable organizations often welcome cryptocurrency donations because the transfers require less red tape than a typical wire transfer.
For tax purposes, cryptocurrency gifts should be treated as gifts of property, in which the done receives the donor’s cost basis in the property, which means the fair market value of the cryptocurrency on the date it was received.
In recent months, the U.S. Congress has held hearings on digitizing the dollar, a sign indicating that cryptocurrency has become an increasingly crucial financial tool for both businesses and individuals. Despite that, however, planning for cryptocurrency has been neglected, leaving behind numerous stories in which people discarded their computer's hard drives, often containing thousands of bitcoins. To avoid forcing your heirs to dig through mountains of garbage to try to find your hard drive, it's best to integrate cryptocurrency into your estate plan to preserve the benefits.
To preserve the benefits of cryptocurrency, take care with recording the private key or seed phrase. Anyone with the right private key or seed phrase can access the cryptocurrency, so any estate plan should include the proper procedures for obtaining and using this information. Cryptocurrency is not traceable, which means there is no electronic or paper trail linking the parties together in a cryptocurrency transaction. That means you will have to secure the information necessary to preserve that level of privacy. Unlike hard currency, transferring cryptocurrency takes only moments and there are virtually no transfer costs. Care should be taken that the entities that are used in planning do not end up re-creating the delays and costs of hard currency.
A second aspect of incorporating cryptocurrency int an estate plan is to avoid risk. Cryptocurrency is not unlike precious metals and other commodities, which can fluctuate wildly even during the course of a single day. Therefore, cryptocurrency should be treated much like a share of stock in a private company and other assets that can be volatile in nature. Since cryptocurrencies exist outside government regulation, no government is responsible for any losses incurred, even if they are incurred because of scams or theft.
If the Prudent Investor Rule applies (and it should), then it will be difficult to include cryptocurrency in your trust or other estate planning device. A trust will need specific language if it is to even hold. If the language is too broad, the trustee may be exempt from damages due to willful neglect. It is important to note that cryptocurrency is taxed as property, not as currency, and the fair market value is set by conversion into U.S. dollars at “a reasonable exchange rate.” Transactions involving cryptocurrency are subject to the capital gains tax regulations. Therefore, if you or your business owns any type of cryptocurrency, your estate plans must reflect that reality.