How does Cryptocurrency and Estate Planning Work?

What is Cryptocurrency or Digital Currency?

Lots of people ask us “What the heck is cryptocurrency anyway?” so let’s start there. The terms “Cryptocurrency” “virtual currency” or “Digital Currency” can be used to describe any type of currency, money, or assets that are managed, stored, or exchanged over the internet – put simply, it’s digital cash. The biggest type right now is called Bitcoin, but there are many many others, such as Ethereum and Dogecoin. It is electronic money that isn’t really recognized as “money” by the government (this is likely to change soon) and has no central controlling authority (the way that banks and financial institutions do). It is accepted as means of payment and can even be provided directly as a means of compensation.

What are the different types of digital currency?

There are many types of cryptocurrencies, and many different assets fall under the names “cryptocurrency” or “digital currency”. For example, Digital currency can include anything relating to cryptocurrency, virtual currency, Bitcoin, crypto, etc. There are about 900 different types of digital currency, with Bitcoin being the most prominent type. Along with digital currency, there are also digital assets, called NFTs, for “Non-Fungible Tokens”. An NFT is a digital asset, such as a work of art, saved in digital format, that can be bought and sold just like a painting you’d hang on your wall.

How is cryptocurrency exchanged?

Digital currency such as cryptocurrencies, Bitcoin, and others, use what is called an electronic ledger system, also referred to as “blockchain”. This system creates a network to mathematically process and track transactions. Blockchain is a system of recording information in a way that makes it difficult or impossible to change or hack the system. It can also be used to make user identities and transaction details anonymous. The system tracks how the assets are transferred, but the identity of the user is kept secret. Meanwhile, digital currency can bypass the bank and financial institution agents (for now) and be provided directly to users. The government is starting to take more of an interest in crypto, and new regulations are likely on the horizon.

How is crypto treated for taxes?

Crypto assets are treated very differently by the IRS since they don’t consider them to be “money”. To the IRS digital currency is not currency, it’s actually viewed as property. Therefore, like property, digital currency is treated as capital assets and is susceptible to the same property tax principles that are applied to property transactions. So, if someone sells their digital currency assets, they may be subjected to short-term or long-term capital gains taxes, just like when you sell your home. The general guidelines for these rules are as follows:

• If the digital assets were received as compensation for services, or as an investment and were held for 12 months or less, then they would fall under short-term capital gain rules and income tax rates would apply.
• If the digital assets were received as compensation for services, or as an investment and were held for 12 months or more, then they would fall under long-term capital gain rules.

What happens to my bitcoin and other cryptocurrencies when I die?

When you die, your cryptocurrency will be considered part of your estate, because most crypto providers do not allow you to name a “payable on death” beneficiary on your crypto account. For example, one of the largest crypto providers is the company “Coinbase”, and they don’t allow beneficiaries to be named on your account. Take this language, sampled directly from the Coinbase website:

"Can I name a beneficiary on my Coinbase account?

Typically, naming a beneficiary on your Coinbase account would be done with your estate planning attorney. Like most other assets, the ownership of your Coinbase account would be transferred according to your will or other arrangements made with your legal counsel. It's not currently possible to name a beneficiary directly within your Coinbase account, rather, in the event of your death, we would follow our standard ownership transfer procedures described above.”

If you can’t name a beneficiary, then the asset cannot automatically pass to anyone at your death, other than to your estate. This means that it will be subject to probate, and your loved ones will need to go through the court system to access it. Unless you plan ahead and follow some expert estate planning advice.

Should I update my Will if I have digital currency?

If your Will pre-dates the concept of crypto, and/or is older than 2-3 years, then YES! You can designate a crypto account beneficiary through your Will. While we do recommend that your Will include access to digital assets (and it must be VERY specific for the crypto provider to actually honor it), it’s more of a safeguard than a primary plan. Passing crypto through your Will is not the best option, as Wills are subject to probate and must go through the probate process, which means time and money.

If you pass away and leave your assets to your spouse or beneficiaries, but your Will doesn't specifically allow access to your cryptocurrency provider/wallet, the provider can DENY ACCESS to your executor or personal representative! Even if your Will says "all my assets go to my kids" the crypto provider can still deny them access, and the funds are lost! How do you know if your estate plan includes appropriate crypto language? Have it reviewed by an estate planning expert. But if your Will is over 2-3 years old, it's highly unlikely that you have the necessary language in your documents. Then you risk losing it forever.

What would be considered a taxable event on digital currency?

If a person exchanges cryptocurrency for cash or if they exchange one type of digital currency for another type of digital currency, then those events could be taxed. There are no tax consequences if one were to change virtual platforms or if they were to purchase more crypto (like Bitcoins). However, when an individual receives a virtual coin as compensation from an employer, that income will be taxed at fair market value. See also the short-term and long-term capital gains rules shown above.

What is a 1031 exchange of like-kind property, and can you use it for my digital currency?

A 1031 exchange of like-kind property is an investing tool that allows investors to swap out an investment property for another to defer capital gains or losses or capital gains tax that you otherwise would have to pay at the time of sale. Since the IRS views digital currency as property, people with digital currency have had the opportunity to exchange the digital currency for something similar without having to pay taxes. However, under a new law only tangible, or physical assets (likes homes) can qualify for a like-kind exchange. That’s because the government is losing tax revenue and wants to requalify digital currency in order to increase its piece of the pie.

How do you access your digital currency?

When someone buys a digital currency, they are given what is called a “wallet.” Unlike a regular wallet, this one holds the user’s public and private “keys.” Without the key a user cannot access their wallet – without access to a wallet means no access to digital currency. Furthermore, unlike traditional assets, there is no third party to control nor rest the key access for the digital currency. That’s why the wallet is so important for someone to put their “keys” in a safe place.

Can you ever lose the money? Or will it eventually be discovered, like regular assets?

If an owner of digital currency dies, without having shared the location of their wallet and keys to anyone, then it may never be discovered. Digital currency is very different from regular assets. With regular assets, they can be discovered through statements and even 1099s after the owner’s death. For now, cryptocurrency can be anonymous, but again, the government is starting to pay more attention to crypto, and this may change in the future.

Can I put my crypto in a trust?

Yes! Most crypto providers, like Coinbase, allow crypto accounts to be in the name of a trust. You can create a trust and name the trust as the owner of your crypto account. The trustee (which in most cases is you) will then manage the assets just how you always have. But if you die, the trust can keep or distribute the assets to your named beneficiaries. With NO PROBATE COURT involvement!

There are many different types of trusts for cryptocurrency, ranging from revocable trusts to more sophisticated trusts that provide tax advantages. At the time of your death, the funds in the trust can be passed on to beneficiaries, or even to charities, which will provide you with some present, and future, tax breaks.

Can I put crypto in my retirement account?

For IRAs, yes, but right now, for 401(k)s, the answer is no. This issue is being reviewed right now. A new bill is being introduced in the House called the “Financial Freedom Act” that will allow cryptocurrency to be part of your 401(k)-retirement plan. Read more about the Act HERE.

There are already some financial companies that will allow you to include cryptocurrency, like Bitcoin, in your IRA. For example, iTrust Capital Inc. will allow you to open an IRA and invest in cryptocurrency right now. But until now, there has not been a big push to allow crypto in a 401(k) plan. All retirement plans are government regulated, but for some bureaucratic (and ridiculous) reason, the is more of a governmental push for control over 401(k)s.

Does Monteforte Law, P.C. protect digital currency in estate planning?

Yes, we make sure that we add language to our Big 3 Documents that specifically apply to crypto. Clients with crypto accounts can provide us with information regarding their accounts, so we can make sure we include it in their estate planning documents. 

The best way to learn about estate planning with digital currency is to schedule a Strategic Planning Session with us. This FAQ provides general information about the topic. During a planning session, we will discuss your specific needs, assets, and strategies. To schedule a session, visit www.BookMyPlanningSession.com or give our office a call at 978-657-7437.