By now you have heard of Bitcoin and cryptocurrency. If you haven’t, it’s because you are a monk living in a cave. Cryptocurrencies are considered purely digital assets in many jurisdictions, including Canada and the US. Note the designation as ASSET. This means that they are real assets, like property. But will there be an inheritance tax on your crypto? Outside of certain tax havens, crypto is taxable like other types of property. This article covers what you need to consider when preparing for the future of your cryptocurrency.
Cryptocurrencies have come a long way since the inception of Bitcoin in 2008. Not only is Bitcoin proving to stand the test of time, but more and more successful ICOs are popping up, releasing many new crypto tokens to the market. Because of this, regulations around cryptocurrencies are increasingly in the news, including the taxation of them as assets.
Crypto and Capital Gains
Understanding the value of your cryptocurrency is important for annual taxes and inheritance taxes. In many countries, cryptocurrencies are taxed in a similar way to other valuable assets. That means that whether you bequeath them to your loved ones, or sell them within a taxable year, in both cases, you are subject capital gains.
I have written another article about what you need to get started with your cryptocurrency and taxes in Canada and the United States. Be sure to check that out for a nice cryptocurrency and tax overview.
Here, I will discuss what you need to know about cryptocurrency and any inheritance tax. Spoiler! It is not complicated. But you still need to know a few things about how cryptocurrencies work in relation to valuable assets.
What is Cryptocurrency and Why it Works
Cryptocurrencies are exclusively digital assets. This means that they do not have a physical counterpart. Nor are they generally backed by any government or bank. The reason for their appeal is that they have essentially reintroduced the barter system to international transactions.
Because strong cryptocurrencies like Bitcoin operate with blockchain and cryptography, they are incredibly secure, private, and transparent. Blockchain technology is the foundation for the success of cryptocurrencies. The technology has since been adopted by many large-scale projects, including Starbucks, Walmart, and Microsoft.
Blockchain relies on many decentralized networks to process cryptographic blocks of data. The key is that each block is cryptographically linked to one another in a sequential chain, using information from the previous block, known as a hash.
As such, it is impossible to change blocks of data that are already in the chain. Because to change one would change them all – a practical improbability. Using blockchain makes information incredibly secure, which is why cryptocurrencies rely on it.
Know Your Assets
Cryptocurrencies are non-fiat currencies. No government controls its valuation or devaluation. Additionally, they are (typically) not backed by any other asset, such as precious metals or real estate.
The first cryptocurrency was Bitcoin. While it remains the most valuable and most famed, it is not the only reputable cryptocurrency in circulation these days. Other examples of very popular currencies are Ethereum and Litecoin.
However, cryptocurrencies can be issued through ICOs. This means that they are not only exchanged as currencies, they are also held as shares in the project, similar to having ‘stock’ in particular crypto. In fact, initial Coin Offerings (ICOs) get their name from IPOs.
Valuation and Appraisal
It is important to understand fair market value when it comes to the valuation of your cryptocurrencies. As I mentioned, cryptocurrencies are assets. If you plan to transfer or bequeath them, then there may be an inheritance tax for the recipient.
Fair market value is a way of estimating an asset’s value should the asset need to be sold relatively quickly. That means that fair market value is usually lower than market value, as the asset is not going to market. In this case, the appraiser just needs to know what price it might get, hypothetically, in order to determine if/how it will be taxed.
Appraisals are typically used to estimate the value of real estate and inheritable items, specifically for future valuation. The valuation process only needs to transpire at the time of transfer, or the time of taxation.
Ownership of Digital Assets and Inheritance Tax
When it comes to ownership of digital assets, the basic rule is that if you have the private keys or seed phrase, then you are the owner. So, presently, there is no official need to include the donor’s or information. As long as they have access to the asset.
However, if you want to gift your cryptocurrency to a charity, then you need to be sure that the gift is made complete. And in terms of taxation and inheritance, this may also need to be made a record of, as it likely counts as a charitable donation tax credit.
If cryptocurrency ownership is part of a living inheritance, then changing ownership will be simple. And in Canada, there may be no tax implication at all.
At present, the Government of Canada does not accept cryptocurrency as a form of legal/fiat-currency. That means that when it comes to taxation and inheritance, cryptocurrency is not treated as cash, but as an asset.
In some ways, this makes it easier to transfer cryptocurrency legally in Canada, because it is just the potential capital gains are considered as part of the asset value. Capital gains and cryptocurrency are treated similarly in the United States as they are in Canada. But there are some differences, so be sure to do your homework.
Cryptocurrencies that operate mostly through the ICO mechanism, rather than as an exchange currency, are considered a form of capital or potential capital. This is relevant for inheritance tax as well as raising capital.
However, if your cryptocurrency is part of your will, then it would be wise to set up a fiduciary.
The Role of the Fiduciary
Cryptocurrency is not like traditional assets, and so it does not need the same kind of intermediaries. With typical assets, your beneficiaries need executors to have an original death certificate and letters of testamentary for your assets to be released.
It is much simpler with cryptocurrency, as I mentioned, so long as the recipient has your seed phrase. This is where a fiduciary may come in handy. It is wise to have a fiduciary that is in charge of supplying the willed person with the decedent’s passcode to access and transfer the crypto-account.
While it is simpler to pass on cryptocurrency in theory, given the increased acceptance of digital assets, it is very important that you understand the regulations around your asset at the time of making your will.
Example of laws you need to know regarding inheritance tax
It is important to ensure that doing so does not violate any federal or state privacy laws, terms of service agreements, or computer fraud and data protection laws in the country or countries your assets are held. Laws that you may need to consider are the Uniform Prudent Investor Act, the Uniform Prudent Management of Institutional Funds Act, the Federal Computer Fraud and Abuse Act, and the Revised Uniform Fiduciary Access to Digital Assets Act.
One concern to consider is that if only one passcode is necessary to access the cryptocurrency account, there is no way to ensure that a former fiduciary who has been replaced by a successor fiduciary will not access your account – despite the lack of authority.
A partial solution to this problem is to require a multi-signature passcode. It may only be a partial solution because with a multi-sig you need all the signatures of the designated signers for the transference to take place. This may or may not be easier when it comes to coordinating your will and inheritance.
Other Options: A GRAT
One of the concerns for leaving your loved ones with valuable property or assets is if they will not be able to afford the inheritance tax. For instance, if you bequeath a valuable piece of land, you do not want the recipient to be on the hook for the property taxes right away, as they may not be able to afford them.
Rather than forcing them to sell the asset, or go into debt to pay the taxes, you can take a precautionary measure, called a GRAT. A grantor retained annuity trust (GRAT) is a financial instrument used in estate planning. It is designed to minimize taxes on large financial gifts to the beneficiaries.
How GRATs for crypto work
With a retained annuity, an irrevocable trust is created for a specific period of time. Then, the living owner of the asset pays a tax when the trust is established. The assets are then placed under the trust and an annuity is paid every year. This means that when the trust expires, the beneficiary receives the assets tax-free.
A grantor retained annuity trust (GRAT) might also be a good idea for cryptocurrencies. Given the inherent volatility of cryptocurrencies, the more valuable the asset, the more the beneficiary stands to be on the hook for a greater taxable asset. This is not a bad thing as such, we want our assets to increase in value, but it can make inheritance more expensive for the beneficiary.
To establish a GRAT, you will need to have an appraisal of the asset, and based on that appraisal, an annuity is established. If the trustee opens up a simple bank account for the GRAT at the time of funding, then the trustee can use the power of substitution to exchange the cash in the bank account for cryptocurrency. This applies to the appreciated value of the GRAT, which locks in the increased value of the cryptocurrency.
Dead Man’s Switch: An Automated Solution
Another option that some of the more tech-savvy may find more appealing is the Dead Man’s switch. This is an automated solution to keeping your digital assets secure and avoids relying on traditional third-party solutions.
The Dead Man’s switch is a third-party computer that sends the current owner of the asset automatic emails which require a response. If the computer does not receive the owner’s response, it begins to search the web for a record of the owner’s death.
Once the death of the current owner is confirmed the assets are transferred from the original cryptocurrency wallet to a specified account, namely the bequeathed.
Available Account Management Products
Contemporary third-party providers such as Safe Haven and DigiPulse have created their own services to ensure that crypto wallets are stored in decentralized vaults. The account transfers automatically to the chosen wallet based on specific signals.
Safe Haven will manage the bequeathment of your cryptocurrency. But allows that the owner can use their tokens at any time. The product uses encryption and splits the initiator’s keys, which are then encoded in the blockchain.
The number of times the key splits can vary. It also depends on what the best suits the owner of the account. Safe Haven also enlists legal entities worldwide via our TAN (Trust Alliance Network). This means that they trigger a legal notation for each individual case along with specific conditions.
One such example is the “Family Circle.” This means that the owner can choose multiple family, friends or stakeholders to add to their wallet. Upon passing, the beneficiaries of the account must reconstruct the key by merging their shares. However, there is the additional security of the “validator,” a legal entity, which is part of the blockchain through a smart contract.
DigiPulse is an example of the dead man’s switch, which requires regular status updates. When the user’s activity stops, the vault will automatically transfer the crypto wallet to the selected recipients that have been set up as beneficiaries.
Digipulse operates with inheritable vaults, which can be modified anytime, and are able to contain any type of file. This program also does not require lawyer and executor oversight. An added advantage is that the inheritor also does not need to have any prior knowledge of the ‘vault’s’ existence to access the contents. Its use of blockchain technology allows Digipulse to encrypt, split, and store information on multiple devices across the world.
Digipulse and Safe Haven are both new solutions for passing down your crypto. But it is still on the individual to know the laws locally for inheritance tax on crypto assets.
Before we finish up, please remember that this is not official or legal advice. This article is a guide to getting going with inheritance and taxation inquiries.
Regulations for crypto-assets are quite different from one jurisdiction to another. So it is up to you to know what kind of regulation you are subject to.
When it comes to cryptocurrencies, laws are fast changing. To find out if your crypto will be subject to inheritance tax, go to official government websites and find securities competent lawyers and accountants.
And on the plus side, as the global adoption of cryptocurrencies continues, they also accrue value!
Finally, it might not be necessary to make all of your arrangements just yet. However, it is no less important to understand the changes that are going on with cryptocurrency. Also imperative is knowing how to best protect and benefit from your assets.
With that in mind, we have got you covered here on the HedgeTrade blog. We offer the latest in cryptocurrency guides, tutorials, and news to all you early adopters so you can stay ahead of the curve. We hope this article on inheritance tax was helpful and got you thinking about the next generation of crypto lovers!