June 16, 2021
It is rare for a brand new type of financial asset to be introduced into our lives. One example in our experience would be mutual funds which, while created in the 1920’s, didn’t become a popular investment vehicle until the late 1970’s. Following on its heels was the exchange-traded fund, developed in the 1990’s.
You have no doubt heard a lot recently about cryptocurrency. This electronic currency system began to take shape in the 1980’s and the first bitcoin was generated in 2009. Its popularity has grown over the past 12 years and today there are many forms of crypto beyond Bitcoin. It is estimated that the combined value of all “significant cryptocurrencies” is about $1.5 trillion, or 4.3% of ‘narrow money.’ We won’t (and couldn’t !) get into the details of how cryptocurrency is mined (created) but that’s not important to our work as divorce financial planners. What we do need to consider is how to treat it when we come across it. This is new territory and there are no standards to guide us.
First, we need to consider how to identify crypto. We have not seen it listed as an asset to be disclosed, so it could easily be overlooked. A tax return may help in this respect. In 2020 the IRS moved the question “At any time during 2020, did you receive, sell, send, exchange or otherwise acquire any financial interest in virtual currency?” from Schedule 1 of the federal tax return to page 1 of the Form 1040 – a prominent position. However, one is not obligated to check “Yes” to this question if the transaction was a simple cash purchase of crypto (and has not yet been sold.) The IRS is really just looking for taxable sales. References to crypto would also show up on Form 8949 “Sale of Capital Assets.” Crypto sales are treated like any other financial asset and subject to capital gains tax.
Barring its disclosure on a tax return it may be necessary to do some sleuthing. Look for notation of the “key” (a password which the owner uses to open their crypto wallet) or a hardware wallet. Crypto may be referenced on loan applications. An attorney can subpoena US crypto exchanges such as Coinbase. If you suspect there is an account but can’t find any evidence, a forensic accountant may be required to examine bank and credit card statements for crypto purchases.
Valuing crypto is also problematic. The daily price can fluctuate wildly - Bitcoin almost tripled in value over the past 1 year but was down 37% in the last 30 days - and a final division of assets may need to be tweaked at the last minute if the crypto value materially affects the total value of all marital assets.
When dividing crypto the cost basis should be considered. Due to price fluctuations the potential capital gain or loss could be large. The good news is that crypto is divisible and carving off a piece for an ex-spouse should not be problematic.
We have yet to work with a client who has divided a crypto account but we know it is in our future. We are ready for the challenge of this new frontier!
