Cryptocurrency’s popularity has exploded recently, but many people don’t know how it impacts their estate plan.
Here are the most important things you need to know.
Know the tax consequences
Did you know that transferring your cryptocurrency (during life or death) could have income, estate, and tax consequences?
Income tax consequences. Essentially, the position of the IRS is that the sale or exchange of a convertible virtual currency may result in taxable gain or loss just as the sale or exchange of other property would. Whether the gain or loss is characterized as a capital gain or loss depends on whether the convertible virtual currency was a capital asset in the hands of the taxpayer, like stocks, bonds, or other investment property. If the virtual currency was not a capital asset in the hands of the taxpayer, such as inventory or other property held for sale in a business, the taxpayer would realize ordinary gain or loss.
Estate and gift tax consequences. Because the IRS considers virtual currency as property, federal gift and estate tax laws apply. Until very recently, cryptocurrency has been quickly increasing in value. And many people whose estate would otherwise have a value less than the estate and gift tax exemption amounts ($12.06 million for individuals, $24.12 million for married couples in 2022) must now include in their estate plans provisions for minimizing gift and estate tax consequences.
If you own cryptocurrency that has substantially increased in value, or that you anticipate will substantially increase in value, it’s important to discuss with your estate planning attorney ways you can minimize potential income, estate, and gift tax consequences.
Technological advances are moving faster than the law
It’s hardly a secret that technological advances are moving faster than the law.
At the same time, as cryptocurrency increases in popularity, more people have cryptocurrency holdings that must be considered part of their estate. Because cryptocurrencies are generally stored in such a way that no personally identifying information is tied to them, cryptocurrency owners must inform their beneficiaries that these assets exist, or they could be lost forever at the owner’s death. Further, owners (and their estate planning attorneys) must provide specific instructions for accessing the cryptocurrency, or the information could also die with the owner. Finally, because managing cryptocurrency requires some technological expertise, it is important to appoint trusted decision-makers with some basic cryptocurrency knowledge.
These factors create unique challenges when dealing with cryptocurrency in your estate plan. A comprehensive estate plan ensures that you and your beneficiaries know about and control what happens to your cryptocurrency upon your death.
How are you holding your cryptocurrency?
The way you hold your cryptocurrency affects your estate plan.
Custodial wallet. A third party, such as a crypto exchange, holds your cryptocurrency, similar to how a bank keeps your money in a checking account. While this is the most convenient option and there is no worry about “losing your keys,” the downside of leaving your crypto in another party’s possession is that they could freeze your funds or be attacked. With this type of wallet, your beneficiary can work with customer support to have the crypto transferred after your death.
Cold wallet. A cold wallet is a physical storage device, such as a USB drive, that stores your crypto offline. The downsides of this option are the cost of the hardware and that the device may be a small object that is easy to misplace, but it is also the most secure option for storing crypto because it cannot be stolen by hackers when it’s offline. You’ll want to ensure that your trusted decision-maker or beneficiary knows where to find the cold wallet and has detailed instructions for accessing the stored crypto.
Hot wallet. A hot wallet is a desktop, web-based, or mobile app that stores your crypto online. While a hot wallet is convenient, the big drawback is that crypto stored online is at the greatest risk of being hacked and stolen. Your estate plan will need to include instructions on how to access the hot wallet.
Paper wallet. A paper wallet is a printout of keys, usually in the form of characters and scannable QR codes. It provides a great amount of security because it stores your crypto offline, but it is the least convenient, and there is also the risk of losing the paper wallet.
No matter how you store your cryptocurrency, your trusted decision-maker must know how it's stored, where it is stored, and how to access it, including how to access all security keys, seed phrases, usernames, and password information.
Because cryptocurrency and the estate planning laws surrounding it are rapidly evolving, it is essential that you work with an estate planning attorney who understands the unique challenges involved in planning for crypto. We can help. Call Santaella Legal Group, serving all of California, at (925) 831-4840.
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