Crypto Taxes and Accounting

Death, Taxes & Crypto: What You Need to Know

Published
October 20, 2022
Written By
Share

Topics

    Nobody likes to think about their impending demise, but failing to prepare for the inevitable could leave your crypto fortune lost forever. While conventional bank and brokerage accounts are easy to find, many people hold crypto assets on obscure third-party exchanges or innocuous-looking hardware wallets that novices might toss in the trash.

    Let's look at how cryptocurrency traders, investors, and enthusiasts can plan to ensure their heirs can access their assets after death.

    Estate planning rules, regulations, and best practices are still catching up with crypto assets. Here's what you need to know to ensure your heirs can access your wealth.

    Start with Documentation

    Cryptocurrencies are notoriously easy to lose. For example, Stefan Thomas famously forgot the password to approximately 7,000 bitcoins on a secure USB device that only permitted ten password attempts before encrypting the hard drive. In fact, by some estimates, more than 20% of all bitcoins are presumed lost (e.g., held in un-accessed wallets).

    Some crypto investors hold their assets in "cold storage" – or offline hard drives or devices. While these devices prevent online attackers from accessing their crypto assets, heirs could have difficulty finding physical devices and passwords without planning ahead. You can avoid these situations with clear instructions and paper-based passwords.

    Many other crypto traders and investors hold their assets in "hot storage" – or online wallets and exchanges. While these devices aren't prone to physical loss, these third-party services may require a death certificate and a grant of probate to access the assets. But you can simplify the process by specifying beneficiaries at the account level.

    Tl;dr: Store the location and password for physical devices in a safe deposit box or another secure place for heirs to access. If you have assets on an exchange, designate beneficiaries to streamline the process for heirs to take ownership of the assets.

    What Happens to Your Crypto When You Die?

    Many states have updated their estate laws to regulate digital assets like conventional financial assets. However, these laws vary by state, and it's a good idea to familiarize yourself with them beforehand. You may be able to avoid a lot of legal headaches with a little state-specific planning, particularly if you hold a lot of crypto assets.

    From a legal standpoint, executors need a list of crypto assets and the necessary information to access them, including any private keys, wallets, passwords, and lists of exchange accounts. As mentioned earlier, if you're using a third-party provider, they may also need a grant of probate and a death certificate to access the account and make transfers.

    In most cases, executors will transfer these assets into a new wallet or custodian for safekeeping during probate. That way, they don't have to worry about other parties that may have access to the passwords or private keys. They may also look for evidence of purchase to ensure that you owned the asset and there aren't any competing claims.

    The next step depends on the will or the executor's discretion. If you didn't specify otherwise, most executors will liquidate any crypto assets immediately and then distribute the proceeds to heirs. That way, they don't have to worry about complaints if prices crash. However, you can direct that the assets be transferred instead of sold.

    Tl;dr: Estate laws vary by state, but for the most part, crypto assets are treated like any other capital asset. To make life easier for executors, generate an updated list of assets and specify how and to whom you'd like to transfer the assets upon your death.

    Will Your Heirs Owe Taxes?

    The IRS considers crypto assets property, subjecting them to the same rules as conventional capital assets. Unless you have an estate worth over $12.06 million, your heirs will not owe capital gains tax on any increase in value seen over your lifetime. They will only owe tax on any appreciation that occurs after your death.

    If you have estate assets worth over $12.06 million, your heirs must pay an estate tax of up to 40%. Many states also have separate estate taxes with exclusion amounts ranging from $1 million on the low-end to $9.1 million on the high-end. As a result, it pays to be familiar with your state's estate taxes and rules to minimize your heirs' tax liabilities.

    There are a few ways to reduce estate taxes:

    • Give away part of your estate as gifts to loved ones while you're still alive, and stay within limits to minimize gift taxes.
    • Give away your assets to qualifying charities and receive a deduction from your gross estate.
    • Shield your assets in an irrevocable trust to legally shelter your assets from state and federal estate taxes.
    • Move to a more favorable tax environment before you die to minimize inheritance taxes.

    Tl;dr: Most heirs won't owe any estate taxes (e.g., death tax). But, if you're over the $12.06 million limit, there are several strategies that you can use to minimize your tax burden and avoid paying these taxes.

    Simplifying the Process

    Several technologies can help simplify estate planning by ensuring that executors and loved ones can access your crypto assets after death.

    Inheriti is a decentralized finance (DeFi) protocol that enables secure digital inheritance. In particular, the platform makes it easy to store passwords, seeds, private keys, lyrics, or any random CBOR data string. At the core, it relies on the SafeKey hardware device, ensuring only qualified individuals can access information.

    Crypto Estate Planning
    Casa is a wallet that has incorporated estate planning capabilities. Source: Casa

    In addition to inheritance protocols, many existing multisig wallets incorporate estate planning capabilities. For instance, Casa's Inheritance program works within the legal system while ensuring that funds only pass on to heirs when it's time. The concierge service even guides you and your family through the entire process.

    Of course, wealthy individuals can also use the same tools they access for existing estate planning, such as trusts or family offices. With significant investment experience, these entities may be able to facilitate the process without relying on third-party protocols or services.

    The Bottom Line

    Estate planning isn't at the top of many people's minds, but planning ahead can help your heirs avoid a lot of headaches. Fortunately, there are a few steps that you can take to plan ahead and avoid problems down the road. In addition, new services and features are launching to help make the process even easier and safer.

    If you trade crypto assets, ZenLedger can help you aggregate transactions across wallets and exchanges, compute your capital gain or loss, and populate the IRS forms you need.

    Sign up today to get started for free!

    Get Started Now
    ZL new logo

    Simplifying DeFi, NFT, and Crypto Taxes for Investors and Tax Professionals

    FB logolinkedin logotwitter logoyoutubrmedium


    Copyright © 2022 ZenLedger
    10400 NE 4th St, Floor #5,
    Bellevue, WA 98004, USA