Cryptocurrency is a digital or virtual currency that is becoming more widely used in business transactions. Last year alone, over $335 billion dollars was held in cryptocurrencies. The IRS has taken the position that cryptocurrencies are not currencies at all. Instead, they are characterized as property or goods and therefore taxed and treated likewise.
Digital currencies have value and must be reported as assets, as part of the value of an estate. This means tax-basis must be tracked.
Many challenges accompany these types of digital assets when being transferred at death. A step-up in basis occurs with digital assets that pass through the estate process. If you have cryptocurrency with a significant amount of gain over the original basis, it may be a good asset to leave to your heirs, as they can receive the step-up in basis to fair market value at your date of death. This means that if they sell the asset right after your death, there is no capital gains tax.
For example, if you bought a digital coin for $1,000 and it is worth $10,000 on the day you die, your heirs will receive a basis in the coin of $10,000, wiping out capital gain taxes on $9,000 of profit on the coin.
Digital assets and cryptocurrencies may make estate planning sometimes complex. Tracking where digital assets exist online and how to access them is critical. If you fail to plan properly, your digital assets may be lost forever. Here are a few planning tips to consider for digital assets and currencies before you pass away:
- Always track and record your personal keys. This allows for access to information for underlying digital currency.
- Monitor online exchanges. Always track and record login, passwords and two-step authentication for all the online service provider exchanges you use where cryptocurrencies are bought, sold and exchanged.
- Consider moving your cryptocurrencies to “hard wallets” instead of using an exchange. You may even purchase encrypted flash drives and external hardware to store digital currencies. But, be extremely cautious because if the hard wallet device is destroyed—the asset could be lost.
- Update your legal documents. Many states now have a version of the Revised Uniform Fiduciary Access to Digital Assets Act that provides rules for giving fiduciaries access to your digital accounts. Make certain you update your legal estate planning documents in accordance with these new laws and your desired wishes.
- Always track and record all digital assets, passwords and locations. This is important for all assets you have digitally, including cryptocurrencies.
- Always track and record valuation of digital assets. Cryptocurrencies have a basis and value that need to be tracked. These assets can impact your estate and the value you pass to heirs.
The popularity of digital assets is here to stay. For planning, taking the proper precautions and understanding the particularities of these assets in estate planning is vital so that they will not be lost, and you can plan for what will happen to them when you pass on.