According to Florida Today, 46 million Americans own the well-known crypto asset, Bitcoin and the number of people owning cryptocurrency is growing steadily. Bitcoin was created in January 2009 by Satoshi Nakamoto as a peer-to-peer electronic cash system. This digital or virtual currency is held secure using cryptography, making it nearly impossible to double-spend or counterfeit.
Most cryptocurrencies are stored in decentralized networks that use blockchain technology. This technology is a database using distributed ledger enforced by a disparate network of companies. Blockchain avoids a central authority that theoretically renders the currency immune to government manipulation or interference. However, because there is no central authority to track or guarantee the safety of cryptocurrencies, there are powerful stories of crypto millionaires losing their assets. These losses often occur because owners lose their private key encryption data allowing them access to their “virtual money.”
It is worth mentioning a report by CNBC that cryptocurrencies are becoming more subject to theft. Crypto mining criminals using a bitcoin mining rig can electronically siphon cryptocurrency. This activity is not illegal in Malaysia and is one of the top ten crypto mining sites worldwide. Although crypto mining requires a special computer that can solve complex math equations, is electrically intensive, and is only sporadically rewarding, there is a magnetic appeal to getting crypto tokens for free.
For estate planning, there are three key elements for handling cryptocurrency. The first and most obvious is documenting the location of your crypto asset’s location and passwords or “private keys.” The data for crypto uses public/private key encryption. As a cryptocurrency owner, your password is a private key that you create that no one else knows. Typically you can store crypto assets in one of four ways.
- An online exchange or custodial wallet
- A hardware wallet
- A mobile wallet
- A local software wallet
Whatever option you select to store your crypto, it is your private key that controls it. The benefit of a private key is it makes hacking your account nearly impossible. The downside is if you misplace or forget your private key, you will be unable to access your crypto assets. Not even the crypto exchange will be able to recover your assets.
After you document your private key passwords and crypto locations, it is necessary to share the information with your estate planning attorney. This action will ensure that the funds will be available to you or your heirs if you lose your information, become incapacitated, or die. Your executor or trustee also needs specific power to access your digital assets as, like your estate planner, they have a moral and fiduciary responsibility not to disclose your information. Your chosen representative should be familiar with managing these types of crypto assets.
Your estate planning document needs to outline to whom the crypto assets will pass. Nearly every state in America has enacted the Revised Uniform Fiduciary Access to Digital Assets Act (RUFADAA). This Act governs access to a person’s online accounts when the owner loses their ability to manage their account or dies.
The IRS considers cryptocurrency an asset and subject to taxation on capital gains. As a taxable asset, how you choose to track your cost basis of crypto assets is important to establish before it is saleable. Under current law, beneficiaries receiving these assets as part of an inheritance get a “step-up” basis which erases any lifetime capital gain appreciation.
These three key elements that can protect your cryptocurrency are not complicated. Documenting your password information and crypto location protects the loss of your crypto assets. Sharing that information with your estate planning attorney and a fiduciary responsible executor or trustee may seem counter-intuitive but is the only manner to recover the asset in the event you are unable to do so. Finally, any sale activity in your crypto asset accounts must be reported to the IRS as a taxable capital gain to comply with the US tax code.
If you prefer more stable investing, you may consider investing in the companies that own blockchain technology patents, as it is impossible to know the future of cryptocurrencies. Yet, there is no denying this asset class continues to rise in popularity among speculative investors and has already made many people wealthy. The lure of crypto investing is enticing, but if you decide to enter the virtual currency market, be certain to protect your crypto assets for your estate. Contact our Louisville office at (502) 631-1488 and schedule a consultation to discuss your particular situation.