The past two years have seen spectacular growth in the adoption of cryptocurrencies.
This has been underpinned by institutional endorsement and payment firms, including PayPal, Venmo and Revolut, actively adding cryptocurrencies to their offering. Generational shifts also played a key role as younger investors flocked to cryptocurrency rather than the more traditional investments such as gold or stocks.
The rise of cryptocurrencies, and the role they will come to play in client portfolios for an increasingly mainstream cohort of investors, will inevitably mean that tax and estate planning advisors will need to carefully consider how this particular asset class operates from both a legal and tax perspective.
In this article, we try to identify and consider some of the key estate planning issues that might emerge.
What are cryptocurrencies and how do you store them?
Unlike fiat currencies – government issued currencies– cryptocurrencies are decentralised, digital representations of value, which are underpinned by the distributed ledger technology known as blockchain.
Cryptocurrencies are stored in a digital wallet. The digital wallet can be stored online, commonly referred to as a hot wallet, or stored offline in a hardware device, commonly referred to as a cold wallet. Every wallet contains the owner’s private keys, without which an owner would not be able to access their cryptocurrency. An article published by the New York Times in January 2021 noted that “of the existing 18.5 million Bitcoin, around 20 percent – currently worth around $140 billion – appear to be in lost or otherwise stranded wallets, according to cryptocurrency data firm Chainalysis” 1.
What is the biggest challenge of owning cryptocurrency from an estate planning perspective?
If a cryptocurrency owner dies without having an appropriate succession plan in place in relation to the succession of their cryptocurrency – including very specific and clear instructions for their executors / heirs with regard to access to online exchanges, digital wallets and private keys – there is an almost certain risk that valuable assets could be lost forever on the death of that individual.
Further, owners of cryptocurrencies should think about trusted third parties to assist their executors / heirs with accessing and dealing with their cryptocurrencies after their death. It may well be the case that the nominated executors / heirs have a detailed knowledge about the workings of cryptocurrencies, but unless the owner specifically knows this to be the case, they should not make the mistake of imputing their knowledge about a complex asset class to their nominated executors / heirs. In addition, executors should be granted appropriate powers in testamentary documents to deal with this particular type of asset class.
What tax treatment applies to gifts and inheritances of cryptocurrencies?
Guidance 2 published by the Irish Revenue Commissioners (“Revenue”) on the tax treatment of crypto-assets states that there are no “special tax rules for crypto-asset transactions” and the tax treatment will depend on the activities and parties involved. The guidance indicates that gains arising on cryptocurrencies (which do not fall within a taxpayer’s trade) are chargeable to capital gains tax (“CGT”) in accordance with ordinary CGT principles.
The original owner of the cryptocurrency will be subject to CGT, to the extent that it has gone up in value since the date on which it was originally acquired. The recipient of a gift of cryptocurrency will be subject to capital acquisitions tax (“CAT”) on the market value of the cryptocurrency at the date of receipt. The recipient may be able to avail of available CAT-free thresholds to shield a CAT charge, and in the event that CAT is payable by the recipient, they might be able to get a credit for any CGT paid by the original owner in respect of the gift.
A step-up in basis of the cryptocurrency should arise on the death of the cryptocurrency owner for CGT purposes. This means that their estate should not be subject to CGT, and the beneficiary should inherit the cryptocurrency at its market-value as at the deceased owner’s date of death. Again, as is the case with gifts, the beneficiary will be subject to CAT on the value of the cryptocurrency.
Interestingly, in the context of remittance basis taxpayers, there is much debate at an international level as to the location of cryptocurrencies for tax purposes. HMRC in the UK have published their view that the cryptocurrency should be considered located in the jurisdiction in which the beneficial owner is tax resident. Recent guidance 3 published by Irish Revenue states that “[t]he first step in determining whether or not the remittance basis applies to crypto-assets is to note that the requirement is that the assets are situated outside the State, and not that they are not situated in Ireland". This distinction is important because, where a crypto-asset exists ‘on the cloud’, it will not actually be situated anywhere and therefore cannot be viewed as ‘situated outside the State'. The guidance further states that “[w]here the location of crypto-assets giving rise to a taxable gain cannot be confirmed by the taxpayer, that gain is chargeable to tax in Ireland based on residency rules”.
Although not entirely clear, it appears that Revenue have adopted the same approach as HMRC and will deem a cryptocurrency to be situated in Ireland, if its owner is Irish tax resident. This means that non-domiciled owners who are resident in Ireland would not be able to avail of the remittance basis of taxation in respect of income or gains on cryptocurrencies. Although the guidance remains silent on the issue, it is likely that cryptocurrencies would be treated as falling within the CAT charge on the death of an Irish resident owner; however it is expected that non-domiciled individuals should not be considered resident in Ireland for CAT purposes in any given year unless they have spent the five prior consecutive tax years resident in Ireland.
The UK branch of the Society of Trust and Estate Practitioners 4 have suggested that the location of cryptocurrencies should be determined by the residency of the “holder of the private key”, and if an individual holds cryptocurrencies via an exchange or trading platform, the holder of the private key may be the exchange or trading platform. This would be more favourable from a CAT perspective and from the perspective of remittance basis taxpayers.
What happens if you lose the private key to your cryptocurrency?
If you lose the private key to your cryptocurrency, you may have a “negligible value claim” and be treated, for CGT purposes, as having disposed of the cryptocurrency for nil value. This would mean that you crystallise a capital loss – equal to the amount that you originally paid for the cryptocurrency – which should be capable of being offset against chargeable capital gains arising on other assets. There is currently no specific legislation in relation to the taxation of cryptocurrencies in Ireland, so cryptocurrency-related losses are not yet ring-fenced. Negligible value claims must be made to Revenue in the year of assessment that the private key was lost or considered to be irrecoverable, but in practice, Revenue generally permit a grace period of 12 months.
What happens to your cryptocurrency held on an exchange if you pass away?
Reputable cryptocurrency exchanges have processes in place to handle cases where an owner passes away having held cryptocurrency on an exchange. In that circumstance, the executor of your estate will have to provide the exchange with several supporting documents such as a copy Grant of Probate which will be taken out once your Will has been proved, a copy of your death certificate and a copy of your Will. As well as this, the executor will also have to provide documentation such as a valid form of identification and the executor will likely also have to undergo the exchange’s AML verification process. In order to simplify this process, it is recommended that anyone who either holds cryptocurrency on an exchange, or who regularly uses the services provided by an exchange, should write a confidential letter to their executors which discloses the member reference number of their account.
How do you value cryptocurrencies for tax purposes?
This is a tricky question, as there is a high level of price volatility associated with cryptocurrencies at the best of times. The Revenue guidance 5 suggests that “reasonable efforts” should be made “to use an appropriate valuation for the transaction in question”. However, given the various different channels through which cryptocurrencies can be acquired, the valuation of cryptocurrencies could prove to be a difficult task no matter how reasonable one’s efforts might be. As a starting point, it is suggested that cryptocurrency owners should keep accurate records of all acquisitions and disposals, which record should include the type of cryptocurrency, date of the transaction, the number of units involved, the value of the transaction in euro as at the date of the transaction, and bank statements / wallet addresses.
So whether you are a nocoiner or firmly in the HODL (“hold on for dear life”) camp, one thing is for sure; cryptocurrencies are likely to become a more common feature of a client’s asset profile. As advisers, we need to ensure that a client has a viable succession plan in place for their cryptocurrencies, which works from both a tax and legal perspective.
Matheson will continue to keep a watch on developments in this space. If you would like to discuss the legal and / or tax issues arising out of this publication, please get in touch with John Gill, Maeve Lochrie or your usual Matheson Private Client Team contact.
1Lost Passwords Lock Millionaires Out of Their Bitcoin Fortunes, New York Times, 12 January 2021
2 Taxation of Crypto-assets Transactions, Tax and Duty Manual, Part 02-01-03 (Last reviewed by Revenue in April 2022)
3Taxation of Crypto-assets Transactions, Tax and Duty Manual, Part 02-01-03 (Last reviewed by Revenue in April 2022)
5Taxation of Crypto-assets Transactions, Tax and Duty Manual, Part 02-01-03 (Last reviewed Revenue in April 2022)