Cryptocurrency Estate Planning: Important Considerations
You’re a person of the times. You embrace new technology and the future. You own cryptocurrency as a store of value, a hedge against inflation and a highly volatile asset. Great! But in doing so, you now have a new problem - you can’t pass down cryptocurrency to your beneficiaries or give it away like you could do with cold hard cash or traditional property. So what’s a person to do?
Note: This article is written primarily for a U.S. audience which is subject to U.S. law. The following content was true at the time of writing (August 2022). However, options and regulations may change at any time and non-fungible tokens (NFTs) are outside the scope of this article.
What is cryptocurrency?
Let’s start with the basics - what is cryptocurrency? Well, for one thing, it is not fiat currency. A fiat currency is a currency that has value because it is produced by a sovereign, centralized government which declares the currency to have value. An example of fiat currency is the United States Dollar (USD). Like many other world currencies, USD was once a non-fiat currency that was value pegged to and convertible for gold.
Cryptocurrency, on the other hand, is a virtual or digital currency that uses blockchain technology to create a digital, decentralized, ledger (historical record) of transactions. To keep one’s cryptocurrency in one’s own hands, the blockchain uses public-key cryptography to keep certain information secret. The “public-key” in public key cryptography is a string of characters that is not secret that acts like an email address for sending and receiving tokens. For every public key, there is a corresponding private key that must remain secret from everyone other than the owner of that secret key. This is because The secret key is required to approve outbound transactions for the public key. In other words, the private key signs transactions which approves coins leaving the public-key address. This means that anyone with the private key can approve transactions for the corresponding public key. You could think of it as a security access code to your cryptocurrency wallet.
“Decentralized” in the context of cryptocurrency means that a peer-to-peer (P2P) network allows a disparate system of computers to connect directly with each other without the intrusion of a central authority - there is no central authority for oversight, reference, instruction, or routing. Transactions can be made without intermediary third parties (e.g. banks), and can be made quickly, in mere minutes. That being said, cryptocurrency appeals to a broad swath of folks looking to diversify their investment portfolio.
One example of a cryptocurrency “coin” is Bitcoin - this is currently the most valuable coin of all time. “Altcoins” are all cryptocurrency coins besides Bitcoin (and arguably Ether). There are so. many. altcoins. The exact number changes daily (new coins come and go), but there are thousands. Well-known examples of altcoins include Ether (Ethereum), ATOM (Cosmos Hub), ADA (Cardano), DOT (Polkadot), XLM (Stellar), and (DOGE) Dogecoin. Some cryptocurrency coins are called “stable coins” which mean that their value is pegged to a fiat currency. As you may have guessed from the name, USDC (United States Dollar Coin) is a stable coin that is tied to the value of the U.S. dollar, as is USDT (United States Dollar Tether). However, the majority of cryptocurrency coins, including Ether, ATOM, ADA, DOT, XLM, and DOGE, are not stable coins - their value is determined by the market, and thus fluctuate like stocks.
How do you acquire cryptocurrency? Assuming you’re not mining it, you could acquire it through a broker or through a cryptocurrency exchange. A cryptocurrency broker provides a user-friendly interface for you to buy or sell, and then interacts with a cryptocurrency exchange on your behalf behind the scenes. It’s like buying cryptocurrency on “easy mode.” Examples of cryptocurrency brokers are Robinhood, iTrustCapital , and even PayPal. A cryptocurrency exchange is an online platform where you can trade cryptocurrency and examples include Coinbase, Gemini, Kraken, and Binance. Buying or selling, either through a broker or an exchange, will usually incur a transaction fee, just like purchasing a stock.
There are a variety of ways to store your cryptocurrency:
Account with Broker - You could store it in your account with a cryptocurrency broker.
On an Exchange - You could leave it on the crypto exchange
Crypto Wallet - You could store it in a “crypto wallet” that is usually an extension on your internet browser (e.g. Google Chrome) or an app on your smartphone.
How does the government treat cryptocurrency?
In the U.S., cryptocurrency currently does not have legal tender status, but can operate as a medium of exchange with the agreement of both parties.The IRS treats cryptocurrency as property, not currency (this is true for all cryptocurrency, even stable coins). IRS Notice 2014-21, 2014-16 I.R.B. 938 says “For federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.” IRS Notice 2014-21 also says that taxpayers realize a gain or loss upon the sale or exchange of cryptocurrency. On the Frequently Asked Questions (FAQs) section of the IRS’ “Virtual Currencies” webpage, it is confirmed that converting cryptocurrency to fiat currency will result in gain or loss.
What considerations do you need to know for making a cryptocurrency gift?
As said above, the IRS treats cryptocurrency as property. Thus it is very important for the owner to keep proper documentation (which can then be provided to the recipient) about the owner’s “cost basis” in the cryptocurrency. When it comes to the IRS, your cost basis is the amount of your capital invested in a piece of property for tax purposes. So here, it means the amount of cold hard cash you shelled out in order to acquire your cryptocurrency. It is also important to know the fair market value of the cryptocurrency assets on the “transfer date,” the time at which they are gifted to the recipient.
At the time of your gift, execute a gift memorandum both for your records and your gift recipient’s records. You may notice a theme here of “Document! Document! Document!” If possible, both you and your recipient should “execute the memorandum contemporaneously” (sign the same document at the same time). If that is not possible, then have your recipient “execute a receipt” for your records (sign and send you a document saying they got it). Here are the details you should include in your memorandum:
The specific cryptocurrency being gifted (both type and amount)
The date of transfer
The fair market value on the transfer date
The donor’s cost basis
A statement that you (the donor) have given up control over the asset
Optionally, specify how you gave up control (e.g. if you sent the cryptocurrency to the recipient’s crypto wallet address)
If you make a charitable donation of cryptocurrency, what is the value of your charitable tax deduction? Well, If it has been held for less than one year, then it’s either the donor’s basis in the cryptocurrency or the cryptocurrency’s fair market value at the time of the donation, whichever is less. If it has been held for more than one year, then it’s automatically the fair market value of the currency at the time of the donation. For charitable gifts, the memorandum should also include a statement that the gift meets the requirements for a charitable deduction.
If you make a bona fide gift of cryptocurrency, that will not result in income to the gift recipient. However, the recipient will want to be able to determine their basis, so it is crucial for the donor to provide their own basis information and supporting documentation to the recipient. If there’s a gain, the recipient’s basis will be the donor’s basis plus any gift tax the giver may have paid on the gift. For a loss, the recipient’s basis will be the donor’s basis or the fair market value of the cryptocurrency at the time of the gift, whichever is less.
What considerations do you need to know for cryptocurrency estate planning?
Cryptocurrency cannot be passed by a beneficiary designation unless the cryptocurrency is held by a third-party custodian such as a brokerage or centralized exchange. A similar problem applies to trusts. Some brokerages, for example Fidelity, will allow a trust to hold an account which owns shares of a cryptocurrency trust such as the Grayscale Bitcoin Trust. However, I am not aware of any cryptocurrency exchanges that permit a trust to own an account.
If you hold cryptocurrency assets, then your estate planning documents should include a definition for this class of asset. Consider your estate planning objectives and how you are gifting this asset class when you create your definition. Terms continue to evolve with regard to virtual assets, so this definition may need to be periodically reviewed.
Cryptocurrency assets should be specifically referenced in your estate planning documents in a place such as the trust asset schedule. If not, it’s possible that your executor and beneficiaries will not know that the assets even exist nor how to access them. Even if the cryptocurrency is stored in a digital wallet, you’ll want to both make an express reference to the cryptocurrency in your estate planning document and grant express powers and instructions to access that cryptocurrency. It’s better to be safe than sorry when it comes to making sure your heirs can “unlock” what you bequeath them. This means making a plan for how to secure your assets while also giving your heirs the ability to access the crypto. One method for this is to use the Shamir’s Secret sharing, which I will describe in a later blog post.
Although most states treat cryptocurrency as intangible personal property, the wallet is usually stored on tangible personal property (e.g. a laptop computer). To avoid confusion and conflict, your estate planning documents should separately address and gift cryptocurrencies. You probably want to add legalese to your estate planning documents that gifts of tangible personal property (i.e. electronic devices) do not include cryptocurrency that may be stored or accessed thereon. Because cryptocurrency is generally considered intangible personal property, you should specify your cryptocurrency gifts in your estate planning document (will or trust), not in an external document, such as a tangible personal property memorandum.
What professional(s) should I hire?
To create a valid, enforceable, and comprehensive estate plan, you want to employ the services of a qualified estate planning attorney in your area. Cryptocurrency is an asset that must be specifically planned for as part of your estate plan. The market will continue to evolve, your estate plan needs to, also.