Tales From the Crypt(o): Estate Planning and Bitcoin

Bitcoins are abuzz.  Goldman Sachs recently announced that it is setting up a cryptocurrency trading desk, J.P. Morgan is backtracking on the position of Jamie Dimon that bitcoin is a “fraud,” and more and more investors – both foreign and in the U.S. – are placing their bets on bitcoin.  

But what, exactly, is bitcoin?  Bitcoin is one of several forms of cryptocurrency.  It is like money in the sense that it is used as payment – in fact, over 100,000 merchants and vendors accept bitcoin in lieu of money, and it can even be used to fund an IRA – but it is unlike money in the sense that it exists solely in its decentralized, digital form.  Bitcoin is not physically represented by tangible coins or bills, and there is no bank where one can go to access an account.

Bitcoin accounts exist and are exclusively maintained in a database called a blockchain.  The blockchain is public but ownership of bitcoin is pseudonymous, meaning that a user’s bitcoin account is linked to a unique bitcoin address and the user’s name is not tied to the account at all.  Bitcoin is accessed by means of two digital keys – one that is public and one that is private.  Both keys are required to access the bitcoin, and the private key is irreplaceable.  Because bitcoin is decentralized, there is no “system administrator” who can send you your private key, and there is no “reset” to obtain a new one.  A lost private key equals lost bitcoin.  

So what does this mean for estate planning?

First and foremost, it means that, if you own bitcoin, it is imperative that you either (a) tell someone about it or (b) document its existence in such a manner that your executor or heirs will be able to discover it after your death.  An executor cannot distribute – and your heirs cannot inherit – that which they do not know exists.  Unlike other types of accounts, which are often made conspicuous through the issuance of statements or 1099s, bitcoin accounts are, by design, completely inconspicuous, and the only way anyone will ever know that you own bitcoin is if you tell them.

The only thing worse than not knowing about a bitcoin account is knowing about it and not being able to access it.  Which leads me to my second point – if you own bitcoin, it is important that you store your private blockchain key someplace where it can be found promptly upon your death.  Without the private key, the bitcoin is as good as lost.  Moreover, because bitcoin is a volatile asset, it is important that your fiduciary be able to access it quickly in order to maintain a diversified portfolio of assets in your estate (or trust, as the case may be), as is required in many states (including New York) under the Prudent Investor Act.    

(Presumably, someone who is tech savvy enough to own bitcoin also owns other digital assets, and, in the interest of ease of estate administration, it is crucial that the usernames and passwords of all digital assets – not just bitcoin – be kept someplace where they can ultimately be found.)

Ensuring that bitcoin can be found and accessed is only the first step in estate planning with bitcoin.  As with any other asset, there are many other factors that must be taken into consideration, including taxation.  The IRS has determined that, for tax purposes, bitcoin is property, not currency.  See IRS Notice 2014-21.  Given the volatility in the value of bitcoin, this asset is potentially highly appreciable, and bitcoin users should consult an attorney to ensure that proper planning is in place (e.g. strategies to take advantage of the step up in basis to ensure that one’s heirs are not hit with a huge tax bill when they transact with the bitcoin). 

In the end, while bitcoin poses some unique challenges for estate planners, it can (and should) be properly accounted for in your estate plan.