by Irina Ling and Steffi Gascón Hafen
Anonymity in an investment combined with the theoretical lack of governmental intrusion draws many to cryptocurrency investments.
However, these positive associations can have a downside: If an investor dies without taking appropriate steps to transfer their cryptocurrency, such cryptocurrency may die with the investor. Furthermore, the relatively quick appreciation of cryptocurrency since its inception means such assets may be a significant part of a person’s wealth at death. Additional consideration should be given to the impact of such assets on the overall estate and how such assets are transferred at death. Anyone owning cryptocurrency should take appropriate steps to ensure their virtual wealth is identified and transferred consistently with their intent upon death, and will not be lost in cyberspace.
Specifically Plan for Your Cryptocurrency in Your Clients’ Estate Plans
The most popular method of directing the disposition of assets at death continues to be through a trust. A trust holds a person’s assets and directs a trustee of such person’s choosing as to the continued investment and ultimate disposition of such assets at death. Incorporating a trust into an estate plan allows a person to avoid a probate administration of their estate, may enable a more efficient use of their Estate Tax Exemption (defined below), maintains the privacy of their estate and dispositions, and gives them greater control and flexibility over investments and dispositions at death.
In addition to listing traditional assets as part of a trust, such as bank accounts and houses, the investor should identify any exchange accounts, digital wallets and cryptocurrency in which they hold a private key to ensure such property is properly included. While a trust offers more privacy than a will, to limit access to private keys, exchange accounts and digital wallets, the investor should only list enough information to identify such virtual assets as trust assets and to put the trustee on notice of the existence of such assets.
Given the complexity associated with cryptocurrency, careful consideration should also be given as to whom the investor appoints as trustee: will the trustee know how or be able to seek out reliable assistance to liquidate, trade or transfer the cryptocurrency to the beneficiaries? If a corporate trustee is chosen, is it permitted to undertake administration of trusts with cryptocurrency? These concerns should be discussed with the first trustee of choice and an alternative trustee should be chosen should the first trustee turn out to be an inappropriate fit.
Incorporation of a “Cryptocurrency Advisor” to specifically advise on such assets may be another alternative.
If the investor intends for the cryptocurrency to continue to be held in trust for their beneficiaries, the trust must be drafted to allow the trustee discretion to retain such cryptocurrency. Most states, including California, have laws on how a trustee must invest trust assets, including a duty to diversify trust assets and act as a prudent investor, absent other instructions in the trust instrument. Given the novelty of cryptocurrency and the potential for such assets to represent a large part of the trust portfolio, some trustees may be wary of maintaining cryptocurrency for fear such an investment is deemed too speculative or renders the portfolio insufficiently diverse for a prudent investor. Thus, additional language should be added granting the trustee discretion to retain, buy and trade cryptocurrency.
Several states, including California, have adopted some form of the Uniform Fiduciary Access to Digital Assets Act. In general, the UFADAA allows an individual to appoint a “digital fiduciary” to have the authority to access certain digital assets if certain conditions are satisfied. An attorney should be consulted to determine whether the state the investor lives in has adopted the UFADAA and to ensure the investor’s trust, will and durable power of attorney meet the requirements of the UFADAA.
Keep Detailed Account and Access Information in a Safe Place
Listing cryptocurrency in the trust will put the trustee on notice that these assets exist in the trust estate, and properly satisfying the conditions of the UFADAA may give the digital fiduciary the authority to act with respect to virtual assets. However, without additional information, the trustee may still have difficulty or be unable to access the exchange accounts, digital wallets and cryptocurrency, making the administration inefficient or possibly risk losing such assets forever.
Thus, the investor should prepare a separate document containing detailed information for cryptocurrency, exchange accounts, digital wallets and hardware wallets including, but not limited to, private keys, usernames, PINs, passwords, and security codes, or find an alternative secure digital archive to store such information, which can be accessed by the trustee when the time comes. Store this information in a safe, secure place, such as a safe deposit box, or if it’s a password-protected digital copy, make sure the trustee has been provided with the location of and the password to the digital copy.
Consider Who Should Inherit Cryptocurrency and How
Although the Internal Revenue Service treats cryptocurrency as a tangible personal property asset (as discussed below), state property law may vary, treating the asset as either intangible or tangible property. How the asset is defined for state law purposes could have a large effect on the disposition of cryptocurrency if not properly accounted for. Traditionally, tangible personal property is thought to include furniture, furnishing, clothing and other potentially low value assets, and may be given little attention in a trust document or nonchalantly allocated outright in a generic distribution provision. Given the potential for highly appreciated cryptocurrency, specific attention should be given to ensure cryptocurrency passes to the intended beneficiary(ies) and in the manner intended, for example, perhaps an 18-year-old beneficiary should not inherit $2 million of appreciated cryptocurrency outright and free of trust?
Consider Tax Consequences and Benefits of Implementing a Plan
Pursuant to IRS Notice 2014-21, the IRS treats cryptocurrency as tangible property for federal tax purposes. Thus, the fair market value of the cryptocurrency on the date of death will be used in computing the value of the investor’s taxable estate for estate tax purposes.
The Internal Revenue Code imposes an estate tax of 40 percent on assets in a decedent’s taxable estate that have a fair market value in excess of the decedent’s remaining lifetime gift and estate tax exemption amount (approximately $11.18 million in 2018), after accounting for relevant deductions. It’s important to evaluate whether inclusion of cryptocurrency in the estate will subject to estate tax at this 40 percent rate.
The inclusion of cryptocurrency at its fair market value in the estate also means upon the investor’s death, the cryptocurrency will receive a stepped-up income tax basis equal to the date of death value. If the cryptocurrency is highly appreciated at death, this can reduce the amount of capital gain recognized by the investor’s beneficiaries upon a subsequent sale of the cryptocurrency.
By proactively implementing an estate plan addressing the unique nature of cryptocurrency assets you can mitigate the risk of losing the investment at death, potentially reduce estate taxes, and provide a platform for the seamless administration and long-term distribution of the assets.