You ignore it at your own peril. Estate planning for cryptocurrency is more complicated and more vulnerable than planning for traditional assets.
Take the case of the young woman who lost $117 million in cryptocurrency when her 30-year-old spouse passed away suddenly without adequately planning for the crypto investments in his estate.
Adequate planning requires a basic understanding of the terminology and issues involved and working with experienced, knowledgeable advisers.
Cryptocurrency — also called crypto or virtual currency — is a type of currency that uses decentralized digital ledgers as an alternative to physical money. Think Bitcoin and Ethereum.
Crypto exists on a blockchain, or distributed ledger. Blockchain is a shared public ledger technology that records and manages the provenance and transactions of crypto. Historical data on the blockchain cannot be modified.
A private key is essentially a very long password used to secure access to crypto. Anyone with the key has access. No one has access without a key, so crypto can be lost forever. Unlike a forgotten-but-recoverable password for an organization or software product, there is no chance of recovering a private key.
A private key can be used to authorize and sign transactions — and to prove ownership, which is critical given crypto’s otherwise anonymous design. It’s a common saying in crypto: “Not your keys, not your coins.”
Given that cryptocurrency exists only on blockchains or distributed ledgers, managing the private key(s) that provide access is critical. Enter the digital wallet.
A hot wallet is an app or website used to buy, sell and pay with crypto and to trade and securely store passwords, private keys and other critical information. Alternatively, a cold wallet is an offline hardware device that holds the private keys. It may be stored in a safe or safety deposit box for security purposes. While a cold wallet is generally more secure because the private keys are never exposed to the internet, it is not as convenient to access and use.
Because cryptocurrency is an intangible asset owned anonymously, it’s more vulnerable to security problems and loss. Some financial institutions also place restrictions on cryptocurrency.
Importantly, there is no transfer on death designation for crypto and the usual means of proving ownership are not available. There is no name or Social Security number associated with the crypto, only the anonymous private key. (Remember ... “not your keys, not your coins.”)
Executors of an estate and trusted advisers must be made aware that the cryptocurrency exists. Often, that communication is accomplished by including a list of crypto assets to supplement estate plan documents.
How the details are communicated to executors and advisers requires critical decisions to ensure security and confidentiality. For example, including private keys in a will, trust agreement or other estate planning document leaves it vulnerable, especially given there is no audit trail for crypto.
Executors need to know where to find the crypto accounts and private keys, all while maintaining security over the keys. They require detailed and up-to-date instructions to avoid the risk of loss.
Although crypto is highly liquid and can be used like cash, for federal tax purposes it is not actually considered currency. It is personal property, similar to stock or gold. And like stock or gold, crypto has a tax basis that may be very different from its current market value.
This has major implications for estate planning and gifting strategies, where choosing the right assets to bequeath or gift can make a huge tax difference.
Giving assets expected to highly appreciate can remove appreciation from the owner’s estate if they are given away before the owner’s death. This strategy could significantly reduce the estate tax liability.
Further, an asset bequeathed from an estate receives a step-up in basis to the beneficiary. The beneficiary’s tax basis is the fair market value of the asset at the date of death. As a result, pre-death appreciation transfers free of income tax to the beneficiary.
Crypto investments come with unique challenges in balancing confidentiality with communication. For those with the knowledge to leverage crypto’s distinctive attributes, it can open new wealth transfer and tax-saving possibilities.
