by Irina Ling and Steffi Gascón Hafen
Cryptocurrency investments have become increasingly prevalent, initial coin offerings are on the rise and countless cryptocurrency exchanges and digital wallets make investing in virtual currencies easily accessible to all types of investors, from seasoned traders to hopeful college students.
Anonymity combined with the theoretical lack of governmental intrusion draws many to cryptocurrency investments.However, these positive associations can have their downsides – if your client dies without taking appropriate steps to transfer his cryptocurrency, the cryptocurrency may die with him. Furthermore, the relatively quick appreciation of cryptocurrency since its inception means such assets may be a significant part of a person’s wealth. 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 their death, and will not be lost in cyberspace.
Specifically Plan for Your Cryptocurrency in Estate Plans
The most popular method of directing the disposition of assets at death continues to be through a trust. A trust holds your client’s assets and directs a trustee of his choice as to the continued investment and ultimate disposition of your assets at death. Incorporating a trust into an estate plan allows your client to avoid a probate administration of his estate, may enable a more efficient use of hisEstate Tax Exemption, maintains the privacy of his estate and dispositions and gives him 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, clients should identify any exchange accounts, digital wallets and cryptocurrency in which they hold a private key to ensure they are property included. While a trust offers more privacy than a will, to limit access to private keys, exchange accounts and digital wallets, list only enough information to identify such virtual assets as trust assets and to put trustees on notice of their existence.
Given the complexity associated with cryptocurrency, careful consideration should also be given to whom you appoint as trustee: will the trustee know how or be able to seek out reliable assistance to liquidate, trade or transfer cryptocurrency to the beneficiaries? If it is a corporate trustee, are they permitted to undertake administration of trusts with cryptocurrency? You should discuss these concerns with your cilent’s trustee of choice and come up with an alternative trustee if the first selection does not turn out to be an appropriate fit. Incorporation of a “Cryptocurrency Advisor” to specifically advise on such assets may be another alternative.
If your client intend for his cryptocurrency to continue to be held in trust for your beneficiaries, you should also ensure the trust is drafted to allow the trustee discretion to retain the 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 its potential 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 for a prudent investor or renders the portfolio insufficiently diverse. 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 (“UFADAA”). In general, the UFADAA allows an individual to appoint a “digital fiduciary” to have authority to access certain digital assets if certain conditions are satisfied. An attorney should be consulted to determine whether the state you live in has adopted the UFADAA and to ensure your 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 your 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 a 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 exchange accounts, digital wallets and cryptocurrency, making the administration inefficient or possibly risking losing such assets forever.
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 trustees when the time comes. Store this information in a secure place, such as a safe deposit box, or if it is a password-protected digital copy, make sure to provide the trustee with the location of and the password to the digital copy.
Consider Who Should Inherit the Cryptocurrency and How
Although the IRS treats cryptocurrency as a tangible personal property asset, as further 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 your trust document or nonchalantly allocated outright to children at death in a generic distribution provision. Given the potential for highly appreciated cryptocurrency, specific attention should be given to ensure it passes to the intended beneficiaries in the manner your client intends. For example, perhaps an eighteen year old should not inherit $2 million of appreciated cryptocurrency outright and free of trust?
Consider Tax Consequences
Pursuant to Internal Revenue Service Notice 2014-21, the IRS treats cryptocurrency as tangible property for federal tax purposes. Thus, the fair market value of the cryptocurrency on your client’s date of death will be used in computing the value of his 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 ($10 million indexed for inflation ($11.18 million in 2018)), after accounting for relevant deductions. It is important to evaluate whether inclusion of cryptocurrency in the estate will subject it to estate tax at this 40 percent rate.
The inclusion of cryptocurrency at its fair market value in an estate also means that on your client’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, this can reduce the amount of capital gain recognized by beneficiaries on a subsequent sale.
By proactively implementing an estate plan addressing the unique nature of cryptocurrency assets you can mitigate the risk of your clients losing their investments at death, potentially reduce estate taxes and provide a platform for the seamless administration and long-term distribution of their assets.
Irina Ling and Steffi Gascón Hafen are both associates at Snell & Wilmer.