Investing in cryptocurrency is a trend that appeals to many because banks and governments cannot directly control this asset, and there is a limited level of privacy involved in its ownership and financial transactions that use crypto. The Internal Revenue Service (IRS), however, takes taxation issues of crypto quite seriously.
Also, there are things you need to know if you intend to include cryptocurrency in your estate plan. A California estate planning attorney can answer your questions about investing in cryptocurrency.
An Overview of Cryptocurrency
If you are considering investing in cryptocurrency and leaving it to your heirs in your estate, you need to understand what it is and how it can affect your tax basis.
Cryptocurrency is a type of digital asset that uses cryptography to secure its transactions and to control the creation of new units. Cryptocurrency is decentralized, meaning it is not subject to government or financial institution control. Bitcoin, the first and most well-known cryptocurrency, was created in 2009. Cryptocurrencies are often traded on decentralized exchanges and can also be used to purchase goods and services.
Some investors hold cryptocurrency as a long-term investment, while others trade it frequently in an attempt to generate short-term profits. When cryptocurrency is held as an investment, it may appreciate or depreciate in value and can be subject to volatility. When cryptocurrency is exchanged for goods or services, any resulting gains or losses could be taxable. As with any investment, you should consult with a tax advisor to determine how cryptocurrency would impact your tax liability.
It is easy to steal cryptocurrency or to lose it forever. Someone merely needs to get hold of your crypto key, the 64-digit code that is the password to your crypto. When someone obtains that password, they then have control over your crypto. Since you cannot access your crypto without the key, if you lose that precious 64-digit code, you have lost the asset itself. You cannot get a new key for the asset. Imagine if you lost your house key, and the result was that you no longer owned your house.
Taxation Issues of Cryptocurrency
Crypto gets taxed just like any other financial transaction with other parties. If someone pays you more than $600 worth of cryptocurrency for services or goods, you have to disclose that on your tax return. If you buy crypto and then sell it at a higher price than you paid for it, you have a taxable gain.
Crypto has a fair market value (FMV) that can determine the amount of taxes due. Even though the FMV fluctuates constantly, so does the stock market, and buying, selling, and inheriting shares of stock can have tax consequences.
Including Crypto in Your Estate Plan
It could be challenging to transfer your crypto to your heirs after your death because they will have to get your 64-digit key. You should never include the key code in your will or trust because anyone who sees your documents could steal the asset using the key. If you write the code on a piece of paper and store it in your file cabinet at home, a house fire could destroy your ownership of the crypto.
Your options are to use a “wallet” to store your key code instead of writing your code on paper or giving the key to a friend or relative and hoping that they never succumb to temptation. “Hardware” wallets are physical devices that store your key code, like a USB thumb drive, but those can get lost or be stolen.
Using a secure, cloud-based password storage software is an option, but again, someone must know where to look to access your key.
Finally, as recent news reports demonstrate, an investment in cryptocurrency could lose some or even all of its value, if the fundamentals of the company issuing the cryptocurrency prove to be unsound.
You should always seek advice from a licensed financial advisor and investigate any investment before proceeding. But with crypto it’s especially important that you plan even for worst-case scenarios. By diversifying your investments across different types of assets you may best ensure that your assets are preserved, even if some of those investments fail to turn a profit. Talk to a California estate planning attorney about tax questions and adding cryptocurrency to your estate plan. Contact our office today for legal help, we offer a free consultation.