Five Estate Planning Tips for Your Cryptocurrency
Did you know that your cryptocurrency is considered property and not currency? Like any property, there are some tricks and traps that you should be aware of.
Most seasoned holders of cryptocurrency are aware of IRS Notice 2014-21. For those unaware, the notice holds that for US tax purposes, cryptocurrency is to be treated as property rather than currency. As such, there are some hidden estate planning traps when it comes to the death or incapacity of a cryptocurrency account holder. To avoid these problems, here are five estate-planning strategies you should take now.
- Make sure your executor or trustee is aware that your cryptocurrency exists.
Due to the anonymous nature of cryptocurrency, if your executor or trustee isn’t aware of its existence, your cryptocurrency will die with you. To avoid this result, set up some method of informing your loved ones that you’re a cryptocurrency holder. Be sure you list your cryptocurrency as an asset in your estate planning documents.
- Make sure your executor or trustee can get your private key
Cryptocurrency isn’t like a bank account where your loved ones can simply contact the institution once your will has been probated. Without your private key (or in the case of a hosted wallet like Coinbase or Circle, your username/password), your executor will be totally powerless to distribute your cryptocurrency under the terms of your will. You can place the private key (and other passwords and valuables) in a bank safe deposit box with the key in a location known only to your executor or trustee.
- Make sure power of attorney allows your agent to access your cryptocurrency
Many of us have a power of attorney document in place. This allows someone to handle our legal and financial affairs if we’re alive, but incapacitated. This person may need to handle your cryptocurrency. To make sure this happens, make sure that your power of attorney document explicitly allows your agent to access either your cryptocurrency specifically, or your digital assets broadly. And like your executor or trustee, your agent under your power of attorney will need access to your private key or login info.
- Consider the basis in your cryptocurrency.
Under current law, when you die your beneficiaries will receive your cryptocurrency along with the tax basis of its fair market value as of the date of death. This step-up in basis is a double-edged sword, depending on whether your cryptocurrency has appreciated in value or depreciated in value since you purchased it.
If you have appreciated cryptocurrency, it makes sense to hold onto it as long as you can so that your heirs can take advantage of the step-up on your death. If your beneficiaries sell the cryptocurrency soon after you die, they will likely avoid paying any capital gains on the sale.
On the other hand, if you have depreciated cryptocurrency, it may make sense to spend it now on your current needs and preserve your cash. Upon spending, you’ll recognize a taxable loss, which can help offset gain on other investments, and you’ll avoid your beneficiaries inheriting your cryptocurrency at a step-down basis. This may result in significant capital gains taxes when sold.
- Beware of the Prudent Investor Act
Most states have enacted some version of the Prudent Investor Act, which requires that executors and trustees diversify investments. If someone dies holding a large amount of cryptocurrency, there is an argument that under the Act the cryptocurrency would be considered an “investment” rather than cash, and a volatile one at that. Such a classification may mean that an executor or trustee may be required under the Act to sell some cryptocurrency and diversify into traditional securities. This result may not be what the deceased party intended.
The good news is that the Prudent Investor Act allows itself to be explicitly overridden. Should you desire your executor or trustee to have the power to hold your cryptocurrency long-term, consider a specific provision in your will or trust absolving him from any liability for failure to diversify. This provision can be broad based to cover all your investments, or be limited only to cryptocurrency.
For more information, contact Roy Johnston at rjohnston@johnstonassociateslaw.com or call (707) 545-6542.