While success in cryptocurrency investing is far from assured, death, sadly, is. Accordingly, it is vital that investors in Bitcoin and other cryptocurrencies are prepared for the unique estate-planning factors that apply to digital assets.
The following steps should be addressed immediately by cryptocurrency investors to ensure that their digital assets are effectively passed on to their heirs or beneficiaries.
1. Record Private-Key Custody & Other Access Details
Unlike bank accounts that can be accessed postmortem, access to digital assets typically requires a variety of private information. This information — and an investor’s digital assets — may be lost forever if an investor fails to record it or share it with a trusted third party before they die.
To avoid this, it is crucial that investors physically record the following private access information and provide for custody of this information to their estate representatives:
Most cryptocurrencies use a public-private key system to ensure that transactions are valid. While the public key is made public every time the investor buys or sells cryptocurrency, only the investor knows the private key.
Private keys are essential to verify ownership and access digital assets and should be recorded. Gaining access to a private key is similar to gaining ownership of a bank account so it is vital that private keys are kept safe.
Creating a physical copy of a private key and securing it in a bank safety deposit box insulates the private key from hacking and may provide the safest means to protect it.
Cryptocurrencies are traded on online platforms commonly known as exchanges. Investors that fail to secure their digital assets in hardware wallets — discussed below — typically have their cryptocurrencies stored on default digital wallets provided by an exchange.
It is important that the username, password and security question information for exchanges be recorded to retrieve digital assets from exchange wallets.
Many cryptocurrency exchanges also require that investors use two-factor authentication to prove their identity when accessing their account and transferring digital assets.
Two-factor authentication is typically accomplished via a mobile application that provides a unique code to be entered into the exchange. Investors who use two-factor authentication should be advised to record their username, password and security question information.
2. Move Custody to Hardware Wallets
Once cryptocurrencies are purchased on an exchange, they are automatically stored on that exchange’s default wallet where they can be accessed electronically by the investor.
Digital wallets, especially those used by exchanges, are susceptible to hacking. Investors should transfer their digital assets to a hardware wallet.
Hardware wallets can be purchased online and are, generally, encrypted flash drives that require a password and/or PIN code to be accessed.
Investors and their heirs may lose their digital assets if their hardware wallet is lost or damaged.
Many hardware wallets support 24-word recovery phrases that help investors restore their accounts if they forget their password and/or PIN code or their hardware wallet is lost, stolen, or damaged.
Investors should purchase secondary hardware wallets and initialize those wallets to be exact replicas of their primary hardware wallets to provide redundant protection to their digital assets.
Investors should record the 24-word recovery phrase, PIN code, password and other access information for their hardware wallets and provide for custody of the information and any wallets in their will.
3. Review Uniform Fiduciary Access
To date, at least 24 states have passed some version of the Uniform Fiduciary Access to Digital Assets Act, or UFADAA. While such laws empower fiduciaries to manage digital assets, they may lack key powers with respect to cryptocurrencies.
For example, in 2017, New Jersey enacted the UFADAA. The New Jersey statute generally enables individuals to appoint a fiduciary to manage their digital assets, which are broadly defined as electronic records. Under UFADAA, electronic records include account information for online exchanges.
Unfortunately, while UFADAA authorizes a fiduciary to access a deceased investor’s exchange account, it fails to consider that the private key — the essential information to remove digital assets from a digital wallet — is not available to exchanges.
Moreover, UFADAA’s limited applicability to electronic records may exclude its applicability to hardware wallets.
4. Determine Tax Basis
The Internal Revenue Service has determined that digital assets are treated as property rather than currency for tax purposes. As such, it is necessary to report the capital gain and loss on digital asset transactions.
Many online digital asset exchanges provide excel sheets that track investors’ historical sales and purchases of digital assets. These excel sheets typically provide sufficient information to determine the tax basis of an investor’s digital assets.
For digital asset trades made on online exchanges that do not track investors’ histories, tax basis can be determined by recording and saving the trade confirmation.
These confirmations typically include the amount of the certain digital asset that is purchased or sold, and the value of that asset denominated in the asset that it was purchased with or sold for — whether that be fiat currency such as U.S. dollars or a different digital asset.
Investors in cryptocurrencies are at risk of losing their assets at death unless they plan ahead. Following the steps above and speaking to an estate planning attorney versed in cryptocurrencies will help ensure that digital assets are effectively passed to heirs or beneficiaries.
Joseph Doll and Michael Kearney are attorneys with Cole Schotz law firm. Mr. Doll is an expert in blockchain, digital assets and regulation, and Kearney focuses on areas of tax and estate planning and estate administration.
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