Cryptocurrency may be the “next big thing” on the level of the personal computer and the internet. The market has already reached a total value of $3 trillion. Investors are attracted to its anonymity and freedom from centralized control by banks or governments. Understanding virtual assets and how they differ from traditional currency can help you serve your estate planning clients. Read on to learn how cryptocurrency will affect your law practice.
Understanding Cryptocurrency
Cryptocurrency is a digital asset that is created and traded online. Computer operators called miners establish new units of the digital currency and record them on a blockchain, which is a string of verified, public transaction records. While the records are public, the identity of the cryptocurrency holder is private. Virtual money is traded on exchanges like Coinbase and Gemini. A cryptocurrency transaction involves the exchange of wallet numbers, not names.
Bitcoin is the most popular and valuable of the thousands of cryptocurrencies on the market. Satoshi Nakamoto invented Bitcoin in 2009, after the global financial crisis (although, Australian computer developer Craig Wright claimed in a recent court case that he was the inventor of Bitcoin, using the pseudonym Nakamoto). One of the reasons Bitcoin is valuable is because, like gold, there is a limited supply. Only 21 million Bitcoins will ever be produced. Other cryptocurrencies include No. 2 brand Ethereum; dog meme-based Dogecoin; and Tether, a “stablecoin” that is tied to the US dollar. The value of cryptocurrency can be volatile, but it enjoyed a good year in 2021: Bitcoin’s value increased by 70 percent, while Etherium’s Ether currency grew by over 400 percent.
Helping Clients Who Own Cryptocurrency
The Internal Revenue Service (IRS) looks at Bitcoin and other digital cash as property rather than as currency. Therefore, if a client purchases cryptocurrency for personal or investment purposes, the profits from the purchase and sale are subject to capital gains tax. The length of time a client holds onto the cryptocurrency determines whether the capital gains are short-term or long-term. Twelve months is the threshold, although most clients will not hold these assets for this long. A taxable event is triggered when the client exchanges cryptocurrency for fiat currency or a different brand of cryptocurrency. If the client is in the business of selling or mining virtual assets, ordinary income tax rates, rather than capital gains rates, apply.
Understanding these issues can help you advise clients about cryptocurrency and how to incorporate it into their estate plans. You can discuss the tax implications and how cryptocurrency losses can reduce their tax bills. Keep in mind that since the passage of the HR 1 tax bill, cryptocurrency holders cannot use like-kind exchanges to defer capital gains tax. You can also advise clients to avoid placing all of their assets into cryptocurrency or falling victim to crypto-related scams.
You should also understand how cryptocurrency is stored. The client’s digital wallet can be a physical item or a place on the internet. The cryptocurrency can only be accessed by public and private keys that are dozens of characters long. That means that the key must be stored safely and included in an estate plan. Remember, the client cannot call someone to reset the password. One investor accidentally threw away the key to half a billion dollars, while others have lost millions from misplacing their passwords. If the cryptocurrency holder dies without revealing the key to a potential heir, the funds are lost forever. Additionally, the client’s estate planning documents should authorize the fiduciary to access the client’s digital assets. Wealth Docx has comprehensive provisions authorizing fiduciaries to access, control, and manage your client’s digital assets.
Nonfungible Tokens
No discussion of cryptocurrency would be complete without mentioning nonfungible tokens (NFTs). These are digital assets that are unique and cannot be divided, like a work of art. They are traded on marketplaces like OpenSea. With sales totaling $23 billion in 2021, these digital collectibles can include any of the following:
- Digital art (with a top price of $69 million)
- Sports collectibles (including animated NBA basketball cards)
- Gaming collectibles and characters
- Music
- Video clips
- Social media posts
- Digital real estate
Digital real estate resulted from someone dividing all of the locations on earth into digital hexagons; so, you could become the virtual owner of the Eiffel Tower or the Taj Mahal. While the value of these assets seems questionable, investors hope these NFTs, like cryptocurrency, will eventually grow in value like rare postage stamps, coins, or baseball cards. An NFT of the first Tweet of Twitter’s founder, Jack Dorsey, sold for over $2 million, so the eventual value of an NFT is impossible to predict.
Another attraction of NFTs is that they offer a connection to a community. If you own a CryptoPunk, for example, you have something in common with Serena Williams, Jay-Z, and Logan Paul. So while you may advise a client not to spend $172,000 on a digital kitten or trade their Tesla for a picture of a porcupine, you never know if such a folly could eventually become a sound investment.
Importance of Cryptocurrency Knowledge
Cryptocurrency is growing so rapidly that several big tech executives have shifted their attention to this sector, including Jack Dorsey. Cryptocurrency is becoming more popular to give as a gift, as it can be bought via Venmo or PayPal and traded on Coinbase and Robinhood. Cities like Miami and New York are developing their own virtual coins. Poor people in developing countries are earning real money by playing blockchain-based games around the clock. Bitcoin is considered legal tender in El Salvador. RadioShack is following this trend by rebranding as a cryptocurrency exchange platform.
The more you know about cryptocurrency and how to incorporate it into an estate plan, the more value you will offer your clients. Cryptocurrency holders may also need your help with techniques for initial coin offerings (ICOs), like-kind exchanges, cryptocurrency assets in foreign accounts, and exiting large gain positions. To learn more about these topics, download the free thought paper, “Planning for Virtual Currencies.”