Over recent years there has been a flurry of investment in cryptocurrency and Non-Fungible Tokens (NFTs). It is estimated that around one fifth of the UK population now own at least one form of digital asset. Private Client & Tax Partner, Hayden Bailey and Associate, Satjivan Aujla outline the legal considerations around these investments in the long run.
The enthusiasm for sizeable gains has captured the attention of the FIRE generation (Financial Independence Retire Early) who are driving surplus funds into this speculative digital gold-rush as an attempt at early retirement. Indeed for some, the dream of their investment increasing 1,000% or more has become a reality.
Given the rising number of estates which now have a ‘digital footprint’, an increasingly important question the Gen Z investors may not be concerned about right now is what happens to these digital assets when they die.
For cryptocurrency and NTFs, the decentralised nature of the asset ownership means that there is no centrally controlled registry where your ownership and title to the asset is recorded. Unlike a share registrar or land registry the assets are essentially owned by whoever has the private key (an alphanumeric password used to access the digital wallet). In effect, whoever has the key is the putative owner and can deal with and transfer the asset.
The anonymous nature of the ownership creates problems if two people have the private key. Who is then the owner? On the face of it there is nothing to stop a 10 year old having the key and effective ownership. A key holder could declare they are holding the assets on trust for several others.
On death, unless the private key is known and the family beneficiaries know the details of the digital wallet, there is no way of accessing the assets, or proving ownership. Research suggest £23bn Bitcoin has been reported to be lost. So, what steps can be taken to mitigate the risks of these potentially lucrative (but intangible) assets becoming inaccessible on death and to help create a more robust ‘digital legacy’ plan?
The first step is to identify crypto assets and to make them known to advisers and/or executors. If the person who holds the assets is the only person who knew of their existence there will be a problem. It is going to be extremely important to keep this inventory up to date and to provide details of how to locate the private keys, the various wallets and exchange passwords. This in itself then becomes a very sensitive document and advice should be taken on how to preserve confidentiality, while allowing access in the event of death.
It is suggested by wallet providers that, in a seemingly unsecure and old-fashioned way, you should write down your private key and keep it somewhere safe. Some suggest that you should ‘split’ your private key and put half of the code in your safe and give half to e.g. your lawyer. This becomes a challenge when you have several keys and wallets and are regularly moving crypto between different wallets. When Gen-Z investors are elderly will they still have kept these pieces of paper safe? Will they still remember the codes? Part of the problem is that many will store all of the information on their phone, which is itself unsecure, easily lost and may well be obsolete by the time of death. That same phone may also act as the wallet itself.
Who knows whether NFT cryptographic art will simply be a curiosity for our grandchildren, or possibly worth billions? It is hard enough a task rummaging through boxes in our grandparents houses after they have died, wondering whether old trinkets might be worth taking on the Antiques Roadshow. Will a future Antiques Roadshow find people taking old flash-drives to computer experts asking them if they can help access a wallet to see if there is anything of value? The crypto-antique expert will presumably ask for the deceased’s private keys. Imagine the frustration if the grandchild can only say ‘I have half of it on this scrap of paper’.
After probate, a Will becomes a public document and so it not appropriate to include passwords and keys in the Will itself. Owners of digital assets should discuss with their lawyer who they wish to benefit from the assets on death. The Will can be drafted to include a bequest of the assets, provided the executors can access them to enable transfer to the beneficiary named in the Will, which might be family or even a charity. If digital assets are not included as part of an estate plan to pass on to beneficiaries, there is a chance that they will be sold or liquidated, which may not be the owner’s intentions.
Some businesses are seeking to promote possible solutions to the problem of accessing the digital assets after death. Some businesses offer ‘multi-sig wallets’, which can give someone a ‘back-up key’ to be used to open their crypto wallets in the case of an emergency. The technology is said to allow the owner’s relatives to retrieve funds on the owner’s death or to allow a third party to do so on behalf of the Will beneficiaries. Owing partly to the fast pace of development in NFT technology and the evolving law in this area, investors should be wary of the security threats posed by cyber-hacking.
It is common to create a trust in a Will. In that case there will need to be a mechanism for the trustees to have access to the single private key. The assets are incapable of being formally registered in the trustees’ collective names, or in the name of a company.
Executors of estates where the deceased held cryptocurrency or NFTs should take advice to avoid risk of criticism on how they should deal with these assets, particularly if there are ongoing trusts contained in the Will. Cryptocurrency is unlikely to be a suitable investment for trustees and trust ownership of NFTs is a challenging concept.
Executors and trustees are in a fiduciary position and are obliged to carry out the deceased’s wishes under the Will trust. Crypto-assets are viewed as a high risk asset class, at present often described as a gamble more than an investment, and so trustees need to carefully consider their duties if such assets are to be retained, given high volatility and therefore potential for litigation from unhappy beneficiaries. In particular, trustees should be mindful of any limits on their powers of investment and the exercise of their duties of diversification etc. These duties should be balanced against a perhaps higher risk appetite amongst younger settlors.
An area where the law has not yet caught up with the increase in popularity of NFTs is in the field of taxation, where there is a dearth of guidance dealing specifically with NFTs, both in the UK and globally. In the UK, HMRC’s recently updated ‘Crypto-assets Manual’ deals principally with cryptocurrencies (although NFTs fall into a slightly different category of digital asset).
Cryptocurrencies like bitcoin are considered by HMRC to be ‘property’ for Inheritance Tax (“IHT”) purposes which means they form part of the owner’s taxable estate on death. The price volatility of bitcoin and other cryptocurrency over recent weeks alone (e.g. huge gains that had been made earlier in the year were completely wiped out in a matter of days as the price of bitcoin fell to around £20,000) gives rise to key considerations.
One question is whether HMRC will take into account the drop in value of these assets when determining the IHT liability on death. Broadly speaking, tax is only due if the estate exceeds £325,000 in total. Tax on value above that level is subject to IHT at 40%, unless a relief or exemption applies. IHT is calculated on the value of the assets immediately before death. There are IHT reliefs available to executors where assets have fallen in value between the date of death and the asset is sold, but at present there is no relief given if the value of the cryptocurrency falls after death. The rules might be updated in the future, but for now this means that executors could in theory be left with a tax liability which is higher than the value of bitcoin if there are further falls.
Executors have a duty to obtain the best price reasonably possible for assets and so it might be better for executors to sell risky and volatile assets after death to avoid these risks. Furthermore, there could be a risk that beneficiaries might criticise the executors if they have not taken steps to sell high risk assets.
One particularly difficult issue is determining where NFTs are situated for tax purposes. This is a key issue for owners with a foreign domicile whose assets abroad may fall outside the scope of UK tax. HMRC’s view is that cryptocurrencies are taxed in the place where the beneficial owner is resident. They may take the same approach with NFTs, especially where the underlying artwork is in digital form, although the law is unclear on this point.
The rise of cryptocurrencies and NFTs highlights the importance of taking advice and ensuring that your advisers are aware that you hold these assets so they can assist you in managing them.
This will include advice on the taxation of the asset on transfer or death. Consideration should also be given to how the assets would be accessed in the event of mental incapacity where affairs can be handled by an attorney provided they are properly appointed.
In all cases the nature of the assets are such that great care needs to be taken to ensure the assets can be passed on, but equally that ownership security is not compromised in the process.