Death, taxes, and the gnawing crypto question

26 May, 2019

It is said quite often that 'you can't take it with you'. This obviously refers to the wealth we accumulate in this life. Once we die, it stays behind with whomever it was passed on to. This is true of digital assets as well. The problem in the digital assets space is one of taxation. How are digital assets taxed upon death? Moreover, can they be inherited by someone else?

We did a little digging to try to figure out what happens with the person's crypto assets upon death. What we discovered isn't actually a surprise: there are very few hard and fast rules anywhere in the world. Cryptocurrencies are still an unknown entity in the realm of death, taxes, and inheritance.

This is good in the sense that the government has not yet figured out effective ways to take your bitcoins when you die. It is bad in the sense that people are left hanging when a loved one with crypto assets passes on. They don't know what to do in terms of reporting. They do not know how to pass ownership from one person to the next. It is all quite ambiguous.

Different tax policies

Tax policies are the easiest thing to understand here, so that is where we will begin. First, note that crypto assets are treated differently for tax purposes from one jurisdiction to the next. In the U.S. for example, the IRS tends to view crypto assets as being similar to traditional securities. Any money made by investing in crypto is reported as capital gains and taxed accordingly.

Unfortunately for Americans, there are no clear guidelines outlining whether or not crypto assets are a legal part of a person's estate. If they are, they can be included in the valuation of the estate, taxed, and then distributed among beneficiaries. If not, who gets them when the owner dies?

Things in the UK are somewhat different. UK law clearly outlines the procedure for inheriting crypto assets just as if they were some other form of tangible property. That makes them taxable. As such, it is a bit easier to know who takes ownership of crypto assets upon a person's death. But even that's not enough to mitigate confusion.

Brits are required to value the estates of their passed loved ones in order to determine whether or not inheritance tax is due. What if a deceased person's crypto assets are enough to cause a mistake to exceed the inheritance tax threshold?

At USD $5,000, a decedent's bitcoins could be enough to force the estate to pay inheritance tax. But what happens if the price falls by $300 the day after the estate is valued, thus putting it underneath the inheritance tax threshold? Which valuation does the family rely on?

Where cryptocurrencies are not legal

Trying to figure out inheritance taxes on cryptocurrency is tough enough in countries like the U.S. and the UK. It says nothing of those jurisdictions where cryptocurrency is not a legal asset. There is monetary value behind that asset inasmuch as the deceased person probably used fiat to buy his or her coins. Yet how you would report that value in a jurisdiction where cryptocurrency is not a legal asset is anyone's guess.

In those jurisdictions, do you tax only the cash value of crypto assets at the time they were purchased, or do you tax their current value now? Do you pay taxes on capital gains along with inheritance tax? The questions are many but the answers few.

Taking ownership of assets

Next up is the question of taking ownership of crypto assets upon a person's death. There are two questions here: who and how? The 'who' could be answered simply by writing crypto assets into a person's will. But that only works in jurisdictions where cryptocurrency is considered a legal asset. If you live in a country whose government recognizes crypto only as a virtual asset, and thereby not real, the 'who' question is answered with the reality that there is nothing to inherit.

As for how crypto assets can be inherited, it is a matter of practical transfer. This is where things get really interesting. To understand why, step back and think about how you might acquire bitcoins for the first time.

Let's say you want to make a Bitcoin deposit at an online casino in order to play. You can buy bitcoins simply enough. Just find a Bitcoin ATM or signup with an exchange like Binance to buy coins.

The process is fairly simple. Ownership is not. Ownership is actually quite ambiguous. The coins you purchase are assigned to your digital wallet. No one knows you own them because your wallet doesn't exist as an official, recognized account with you as its owner of record. Your wallet is really just a bit of digital space floating around in the digital universe.

This is why it is possible to establish a wallet and purchase cryptocurrency with nothing more than an e-mail address. The crypto universe doesn't care about coin ownership. It only cares about where coins reside. You could turn your digital wallet over to a friend and all of your coins goes with it. Your friend could then transfer those coins into his wallet, and you would never get them back. He becomes the owner by virtue of the fact that the coins are in his wallet.

Getting around reporting

Ownership ambiguity does create a problem for inheritance. But what appears to be a systemic weakness is also a great strength in that private, digital wallets make it possible to get around reporting digital assets.

As a case in point, Cointelegraph reported earlier in 2019 that American cryptocurrency owners responding to a survey acknowledged at a rate of 53% that they plan to report crypto assets on their 2019 tax returns. That means the remaining 47% plan to not report.

This is important when you consider that the IRS has no means of tracking down those crypto assets for the purposes of tax enforcement. Most exchanges are unregulated, so they are not compelled to report any of what they do to taxing authorities. And even if exchanges did report, they would not necessarily be able to tell the IRS anything about those people who bought and sold through their platforms.

A cold storage solution

Hopefully you now understand how convoluted the inheritance and tax issues are relating to cryptocurrencies. Deciding what to do with crypto assets after a person's death is exponentially more complicated than figuring out how to play slots online with Ethereum or Litecoin.

Until governments figure all this out, one proposed solution is the cold storage solution. Cold storage in the crypto universe is a means of storing crypto assets offline and in a secure location. Examples include USB flash drives, CDs and DVDs, and even paper ledgers.

Let us say you store all of your digital assets on a USB flash drive stored in a safe deposit box at your bank. You also have a backup copy on a flash drive stored at your son's house. Upon your passing, your son could obtain the flash drive from your safe deposit box fairly easily. Then he would have the original and the backup copy in his possession.

As far as inheritance goes, transfer of the assets has already taken place. There is no legal paperwork required. No permission needs to be asked, no trustees have to be consulted, and no asset sale has to take place. Simply by possessing those flash drives your son now owns your cryptocurrency.

He could simply assume ownership of your wallet and that would be that. If he wanted, he could transfer your coins into his own wallet and then dispose of the two flash drives. All of this can occur without taxing authorities having any knowledge of it.

The questions answer themselves

When you think of cryptocurrency in the realm of cold storage, any questions about inheritance and taxes answer themselves. In the absence of formal government control over digital assets, there really is no way to prevent passing those assets on to others outside of estate valuations and inheritance taxes.

A January 2019 CCN article written by P.H. Madore just about sums up the entire matter. The article was about a man named Hal Finney and the incredible wealth he built on Bitcoin. Some speculate Finney might even have been the legendary creator of the Bitcoin platform under the pseudonym Satoshi Nakamoto.

Whether he was or not, Finney died back in 2014. He mentioned in an interview before his death that he was not at all concerned about passing on his crypto wealth when he died. He said, "my bitcoins are stored in our safe deposit box, and my son and daughter are tech savvy. I think they are safe enough. I'm comfortable with my legacy."

Finney reported his gains on Bitcoin as capital gains during his lifetime. Whether or not his children paid inheritance tax on his crypto assets upon his death is unclear. But the implication of his statement about those assets being stored in a safe deposit box suggests they probably knew what they were doing.