Cryptocurrency – A Digital Legacy

Recent FCA research found that nearly 4.97 million people in the UK hold some form of crypto asset, accounting for nearly 10% of the population.

Perhaps unsurprisingly, a recent survey from Forbes Advisor has revealed that those aged 18-34 are twice as likely to own cryptocurrencies than those aged 35-54. Generational differences about investment strategies are only growing. Discussions about long-term investment strategies and succession planning are often undertaken later in life, as individuals and families consider how they might pass on their wealth to other family members, however there are clear benefits to having these conversations earlier, particularly with new investments, like crypto, on the rise. Indeed, crypto presents its own unique set of challenges when navigating financial planning and accessing assets after death – in large part due to complicated questions of ownership and identification.

Who holds the key?

When it comes to asset ownership, cryptocurrency and NFTs are decentralised. This means that there is no centrally controlled registry where your ownership and title to the asset are recorded. Unlike a share registrar or land registry, crypto assets and NFTs are essentially owned by whoever has the private key needed to unlock the digital wallet and access the assets.

One way to think about ownership of cryptocurrencies is in relation to cash or other bearer instruments – whoever holds the key to the wallet controls the asset. HMRC takes the view that the holder of the keys is the owner, and the tax residence of the key-holder determines the tax status of the asset. HMRC also considers that blockchain tokens (be that cryptocurrency or non-fungible tokens, such as digital artwork) are intangible assets that can be held as taxable investments. Regulating the trading of digital assets presents its own set of problems and Governments and tax authorities are seeking international transparency of ownership to help effectively regulate this area of trade. However, due to the fact that financial institutions are not required in blockchain transactions, the Government and tax authorities cannot rely on these institutions to enforce international reporting standards. After all, the ‘removal of the middleman’ has been heralded as one of the advantages of blockchain technology and the decentralised economy.

The decentralised nature of crypto has the potential to create headaches for executors of Wills, given their legal duty to manage the deceased’s assets. It is possible that they may not be aware of the assets or, even if they are, they may not be able to find them if they do not have the digital keys. This could result in beneficiaries of the estate losing out, despite the best intentions of executors.

Cryptocurrency & IHT

Beyond these logistical hurdles for executors, the tax implications are also complex. For instance, digital keys could be found years on from the death, long after the estate administration has been tidied up by the executors. If the assets are subsequently found, the value of crypto assets then have to be worked out by the executors by calculating their value immediately prior to the death. Inheritance tax (at the rate of 40%) will have been due 6 months after the end of the month of death, meaning these newly accounted assets will have to be submitted to HMRC. Interest and late penalties may have accrued in the meantime, and the executors will have to turn to selling the remaining crypto to pay the tax off. The current economic context also has the potential to further complicate matters. After all, if the current crypto market instability continues, the value of crypto assets several years after death may have plunged significantly.

Given crypto is still seen by many as high-risk, the law firm acting in the administration may not want to accept cryptocurrency sale proceeds, or similarly banks may not agree to open an account to hold the funds.  If they struggle to sell on the crypto assets to pay the additional inheritance tax, executors may have to resort to requesting beneficiaries return distributed funds. While this presents a worst-case scenario, it is easy to see how the financial complications could spiral out of an executor’s control.

Disclosure risks

To combat some of these potential challenges, surely there are simple steps digital asset wallet providers can take to ensure that private keys are not lost? Writing the keys down on a piece of paper, or giving part of the key to your lawyer, have all been floated as potential solutions. However, as with any other assets, the deceased and the executors have a responsibility to ensure assets are accounted for accurately. Governments globally are starting to recognise the issues of crypto asset tracing however, with a consultation in the UK to explore robust standards concluding earlier this year.

As change continues apace for the crypto space, only time will tell whether the law is able to keep up as more and more digital assets find their way into estates. Statista estimates that the UK crypto user base is expected to increase to 22.23 million by 2027. Clearly, crypto needs to be accounted for within estate planning going forward if executors are to avoid a tax minefield. Whether a robust legal framework can be found to mitigate against disputes arising from this shifting landscape remains to be seen.

This article was first published in European Financial Review in December 2023.