Unless you’ve been living under a rock for the last ten years or so, you have probably heard of cryptocurrencies like BitCoin. However, having heard of cryptocurrency has no bearing on whether you actually understand what it is and how it works. In fact, it’s absolutely possible that you own some cryptocurrency and don’t fully understand how this asset will function as a part of your estate. So, that’s where we come in.
As estate planning attorneys, we work with our clients not only to help them protect the assets they have, but also to help them build and preserve wealth to be passed down to future generations. So, we love when clients come to us with questions about how best to build sustainable, long term wealth. One of the questions we get a lot is: are cryptocurrencies a good way to build generational wealth?
What is Cryptocurrency, Anyway?
Before we dive into whether cryptocurrencies are a good or bad idea for building wealth, let’s back up. What is cryptocurrency, anyway? If you’ve been afraid to ask, never fear!
Cryptocurrency is a digital asset (only available in digital form) that is transferred using blockchain technology. Blockchain, at its most basic definition, is a decentralized public ledger that allows for a secure and immutable record of transactions. Here’s how it works: a transferee wants to buy some cryptocurrency. So, he or she shares a unique public address where cryptocurrency should be transferred. The transferor (the current owner of the asset) enters the transferee’s address, the transfer amount, and a note. Once the transferor hits “send.” the decentralized network of computers validates the transfer. Once validated, the ledger is updated to reflect the transfer.
At its outset, there was a lot of buzz around how cryptocurrency would completely change the global economy. In fact, there was a major boom in purchasing cryptocurrency (and, as a result, in its value) a few years ago, followed by a fairly significant slump. Now, in 2019, cryptocurrencies have resurged in value and new kinds of cryptocurrencies are being announced (Facebook’s Libra is one example).
How is Cryptocurrency Transferred After Death?
As enterprising individuals turn to cryptocurrency to build wealth, questions arise as to how these assets can be preserved and passed down to future generations. What happens to these assets after the owner dies? Let’s take a look.
The first thing we have to understand about cryptocurrency and how it passes to heirs is the IRS considers cryptocurrency to be personal property, not currency. That means that, for the purposes of estate planning, we have to treat cryptocurrency more like real estate than like a bank account. The transfer of cryptocurrency can result in losses or gains based on the increase and decrease of value. Unlike stocks or bonds, there are no dividends and no interest.
This means that, if you purchase one cryptocurrency coin for $1,000 and then it increases in value to be worth $10,000, you could be taxed on that gain if you choose to sell the coin in your lifetime. If, however, you do not sell that coin, and it is transferred in ownership to your adult son, he would receive the asset on a “stepped up” basis, meaning valued at its fair market value on the date of your death. This essentially eliminates the taxes due on that $9,000 gain.
As personal property, cryptocurrency can be transferred to heirs through either a will or a trust. However, as a digital asset, there may also be terms of service signed with the online asset management account that could take precedence over estate planning documents. If you currently own cryptocurrency and are interested in incorporating it into your estate plan, the first thing to do is locate and read through the terms of service agreement. Then, the estate planning documents can be amended to accommodate your digital assets.
There is a uniform law that establishes rules and regulations for digital account ownership and fiduciary involvement. The State of Georgia adopted the Revised Uniform Fiduciary Access to Digital Access Act in 2018. This law spells out the digital access rights for fiduciaries in the event of death or incapacity of the cryptocurrency owner. Review this law, alongside your estate planning documents and terms of service to get a full picture of how your cryptocurrency will be handled after you’re gone.
Because cryptocurrency is still relatively new, there are circumstances that have not yet been worked out by the IRS and the court system. For example, it is not yet clear how cryptocurrency should be handled when transferred as a charitable contribution or into a retirement account.
Certainly, the addition of cryptocurrencies does complicate estate planning to a certain extent. However, being intentional about how cryptocurrencies are managed can go a long way.
So, What Should I Do with My Cryptocurrency to Make Sure it Transfers to My Heirs?
Because of the anonymous nature of cryptocurrency, there is no bank or oversight mechanism to notify your beneficiaries about the existence of your cryptocurrency. If you die without communicating the existence of your cryptocurrency (and how to access it) to your loved ones, they will never get it. In the same way, it’s not possible for your heirs to simply submit proof of your death and gain access to your accounts. The only way to access cryptocurrency is with the passcode. So, let’s talk process:
Track Where You Hold Assets Online
Without proper planning, your online assets could end up stuck in the cloud forever. So, the first thing you need to do to preserve your virtual assets for future generations is keep track of where and in what amounts you hold cryptocurrency.
Keep Careful Records
To ensure your fiduciary and heirs will be able to access your cryptocurrency, keep careful records. This should include tracking logins, passwords, and authentication procedures for online service providers where cryptocurrency is bought and sold. It is also a good idea to track basis and valuation regularly to help with taxes.
Transfer Passcodes Safely
If you die or become incapacitated, your fiduciary will need to have your private passcode in order to access and distribute the currency as you’ve specified in your estate plan. You can choose to transfer these passcodes in a number of ways. Of course, there is the time-honored “write them down” and keep the list in a safe place, like a safety deposit box. For those more electronically-inclined, you can also choose to use an encrypted digital archive or something called a “hard wallet” (you may have also heard this referred to as a “cold wallet”). A hard wallet is an encrypted flash drive or external hardware that stores passcodes and cryptocurrency information. The good thing about this storage option is that, because external hardware is not continuously connected to the internet, it is more protected against hackers. The downside, however, is if the hardware is lost, stolen, or damaged, the assets are, too.
Think Carefully about Your Fiduciaries
Unlike a bank account or other financial asset, cryptocurrency does not have a governing body that oversees transactions (that’s part of the “decentralized” element). For that reason, it is incredibly important that you choose your personal representative and/or trustee carefully. Anyone with the passcode can access and make changes to cryptocurrency. If a personal representative or trustee makes a transfer that is not in accordance with your wishes (i.e. steals it), there is very little that can be done and the funds may be impossible to recover.
Ensure Your Estate Plan is Compatible
Again, fiduciaries will never be able to transfer digital assets in accordance with your wishes if they don’t know you have them. Make sure that you acknowledge the existence of the cryptocurrency assets in your estate planning documents and give permission for a named fiduciary to access and manage those assets. Because not all assets will necessarily be included in a list as a part of your estate plan, it may make sense to also explicitly give your fiduciary permission to access your laptop and cell phone.
If you have a trust, it is theoretically possible to fund a trust with cryptocurrency. This will basically entail giving the trustee access to the passcode or hard storage device.
I Need Help! Where Should I Look?
If you find all of this estate planning stuff overwhelming, or if you are considering brushing this off until a later date, hang on! Let’s talk. At Brian M. Douglas & Associates, our experienced estate planning attorneys are here to walk you through every step of the way. Give our office a call to make an appointment today.