As digital assets have become more prevalent in today's financial marketplace, several questions have been raised about their taxation. Although the United States continues to make progress on federal cryptocurrency legislation, many issues remain unresolved. Here are the main points to keep in mind if you're interested in taking advantage of these assets.
The IRS and other tax authorities have taken steps to tighten regulation. For example, they have issued mass-mailed letters to taxpayers who trade in secondary digital asset exchange. Those same authorities have also used court orders to require exchanges such as Coinbase to disclose transaction information. These actions have the same consequences as failure to report capital gains. However, because the nature of these transactions is so complex, they can be challenging to track.
Aside from the regulatory complexities, the potential of digital assets to improve your estate planning is immense. In a recent Holland & Knight alert, the firm pointed out some of the ways in which digital assets can improve your estate plan. It also discusses the risks of investing in this technology and offers a variety of possible strategies.
Digital assets are not limited to cryptocurrencies, however. Other mediums of exchange, such as contracts and other items recorded on the blockchain, are considered digital assets as well. And, while these products may not be regulated as securities, they could be categorized as "investment contracts."
One of the more interesting aspects of digital assets is their ability to transfer without a title. Investors can transfer ownership in their digital asset to a trust or trusts. This could lead to substantial gains and/or losses. Alternatively, they could be sold. If this occurs, the gain should not be taxable in the individual's state of residence. Similarly, the sale of a digital asset should not trigger an estate tax liability.
The best strategy to protect your digital assets is to hold them in a properly structured trust. This could include a charitable lead annuity trust. Another option is to set up a partnership to own the digital asset. When it is time to sell, the partnership can step up its inside basis to match its outside basis. Alternatively, an investor can sell a partner's interest to a promissory note of equal value.
In addition to providing privacy and avoiding the dreaded "mark to market" taxation, digital assets are an exciting and new opportunity for cutting-edge estate planning. However, due to the dynamic nature of the regulatory landscape, investors need to pay close attention to any new legal developments and be prepared to adapt their business operations accordingly.
The tax authorities are getting more focused on digital assets. They are trying to find a balance between maintaining and stretching existing legislation. While the IRS has offered guidance on certain areas of digital marketplace taxation, it is not yet clear how capital gains treatment and other tax laws will apply to digital assets. Ultimately, it will be up to the nation's governments to choose between extending existing legislation and supporting new digital asset taxes.