Cryptocurrency’s decentralized nature has changed the world of global finance. However, because it is so new and volatile, the crypto market’s dizzying ups and downs can be difficult to interpret. Is the recent “crypto winter” just one of these regular fluctuations, or does it indicate permanent problems with the viability of crypto? Virtual assets may now be a significant component of your estate planning clients’ portfolios, so keep reading to learn more about the future of these investments.

What Is Crypto Winter?

The recent downturn in cryptocurrency fortunes is significant enough to have its own name: crypto winter. Losing $2 trillion in value since 2021 is enough to make any market’s experts take notice! Bitcoin’s value alone dropped 70 percent in nine months. Experts are looking back at cryptocurrency’s limited history to compare this downturn to the last crypto winter, which occurred in 2017–2018. While that drop was attributed to the bursting of a “hype bubble,” this crypto winter is related more to a decline in the mainstream economy, with Bitcoin and Nasdaq losing value simultaneously in the second quarter of 2022. 

This crypto winter has exposed some weaknesses in the system. For example, the dollar-pegged Terra coin collapsed, leading to the bankruptcy of Three Arrows Capital, a Singapore-based hedge fund. Popular crypto exchange Coinbase laid off 18 percent of its employees. Even cryptocurrency miners are struggling to pay the bills for their electricity-guzzling computers.

Learn how to advise clients who have cryptocurrency at WealthCounsel’s Advanced Estate Planning Summit October 17, 2022

What do the experts say? Robert Brunner, the chief disruption officer at the Gies College of Business at the University of Illinois, said that with inflation increasing, “investors have pulled back from risky assets, including cryptocurrencies.” However, he states that crypto is not going away, citing the “real use cases” of the functionality of blockchains. "Anyone thinking about this asset class needs to remember its historic volatility. In the case of bitcoin, it’s been cycling up and down since its inception. I believe we are just experiencing the decline of the latest cycle," Brunner added.

Other experts are looking forward to shedding their crypto winter coats. Anthony Scaramucci, founder of Skybridge Capital, said now that the “leverage has been blown out of the system,” he expects the price of bitcoin to surge from $24,000 to $40,000. Nigel Green, leader of asset manager the deVere Group, said, “I would not be surprised for it to hit $70,000,” which would be a record high.

What Does This Mean for Estate Planning Attorneys?

Despite its relatively new status and price volatility, cryptocurrency seems to be here to stay. The 2022 Industry Trends Report reveals that 64 percent of respondents have clients who have asked for advice on these digital assets. This is a strong indication that cryptocurrency is not a fad, but rather, is a viable part of the global financial landscape. At a minimum, estate planners must understand crypto to be able to advise clients who seek guidance on capital gains, tax reporting requirements, exiting large gain positions, and other relevant issues.

Capital Gains

The Internal Revenue Service (IRS) considers cryptocurrency to be property rather than currency. That means appreciation in value is subject to capital gains tax. The determination of whether a capital gain is short-term or long-term depends on whether the client has held the asset for more or less than twelve months. Most crypto investors will fall into the short-term category, but many will lower their tax bills if they have the patience to wait until their investments qualify for long-term treatment.

Ordinary income tax rates apply to short-term capital gains or to people who trade cryptocurrency for a living. Capital gains or losses are determined by comparing short-term gains and short-term losses, doing the same for their long-term counterparts, and then adding those numbers together.

Tax Reporting Requirements

Like other investments, cryptocurrency can affect a client’s tax bill, because taxpayers can claim losses as deductions. Another piece of tax-related advice is for clients to open separate wallets for their crypto purchases so they can track their gains and losses more easily.

You can also advise clients about two important triggers of taxable events:

• Exchanging one type of cryptocurrency for another (such as Bitcoin to Ethereum)
• Exchanging cryptocurrency for fiat currency (such as Dogecoin to US dollars)

Purchasing new cryptocurrency and switching to a different trading platform are not taxable events. For information on foreign accounts, initial coin offerings, and like-kind exchanges, click here.  

Exiting Large Gain Positions

Sometimes a client will want to get out of a large gain position to reduce tax exposure. One method is to invest the gains in a qualified opportunity zone, which is located in an economically disadvantaged area. Other, more drastic, options include the client renouncing their American citizenship or relocating to Puerto Rico. Expatriates are exempt from US taxes, while Puerto Rico has unique tax benefits for those who live there for at least half of the year. These types of moves could be part of a larger lifestyle change. In a recent survey, 4 percent of respondents said they had gained enough money in cryptocurrency to quit their jobs.

Sharpen Your Crypto-advising Skills at WealthCounsel's Advanced Estate Planning Summit

Despite the volatility of the cryptocurrency climate, crypto assets are increasing in importance to your clients. Understanding the crypto world will serve your law practice and your clients well. Sign up for WealthCounsel’s Advanced Estate Planning Summit, taking place October 17 and 18. This event qualifies for 4.5 CLE credits and will focus on cryptocurrency. National thought leaders will discuss topics such as the following:

• Strategies to protect assets against lawsuits and creditors’ claims
• What estate planners should know about cryptocurrency and nonfungible tokens
• Valuation and reporting of cryptocurrency on income, gift, and estate tax returns
• Fiduciary administration and estate planning ideas, considerations, and practical tips for cryptocurrency

Click here to learn more and register for this virtual event today.