Crypto estate planning: Will or living trust?

Even though most crypto traders are under 40, estate planning is especially important for them because of the complexities of the digital asset class and the high value of some investors’ portfolios. The estate planning process involves many difficult decisions, but one of the most important is whether to leave a will and testament, or establish a trust.

A last will and testament names an executor and passes on the decedent’s instructions for distributing their assets upon their death. A living trust comes into effect before a person’s death. It is a financial agreement that gives the grantor continued control of the trust’s assets until death, at which time control passes to a successor trustee. Wills are typically simpler and less expensive to prepare than trusts, which are complex financial documents that can cost thousands of dollars to establish.

However, a trust lets an estate avoid probate, something a last will and testament doesn’t do. Probate can be a long, burdensome process for someone’s survivors. Any probate can be difficult, but the process can be especially challenging for those with crypto because it is an asset class that many probate courts and executors don’t know much about.

I typically advise that crypto investors set up a trust. Here is some guidance you can review and use in your practice.

Choose a revocable living trust

Revocable living trusts are a good choice for many crypto investors. Although irrevocable trusts may result in estate tax savings for clients, their terms are final. This doesn’t give the grantor the flexibility to adapt the estate to changing personal or financial circumstances. Seventy percent of crypto investors are under 44, so there’s a fair chance that they will want to change their trust’s terms before their death.

Your client needs to name the trust with something like John Smith Living Trust Dated 01/01/2000. More importantly, remind them that they’ll need to title any future transactions and accounts in this name. Existing assets will be moved to the trust in a signed statement of transfer, except for existing real estate assets, which will need to be transferred by quitclaim deed. 

Recordkeeping is vital to a smooth estate settlement. It helps ensure crypto assets are included in the trust and accessible by successors. You’ll find more content on recordkeeping in this recent blog for the Intuit® Tax Pro Center.

Benefits of a revocable living trust

There are many benefits to having a trust, rather than simply having a will—some are tax-related and some are not.

Non-tax benefits of a revocable living trust:

• Avoids probate and related court fees for beneficiaries.
• No delays in transferring assets.
• Maintains privacy: A last will and testament goes into public record, while a trust allows your client and their loved ones to “keep everything in the family.”
• Prevents court control of assets in case of incapacity: If the grantor is alive, but incapacitated, a trust allows the successor trustee to manage the grantor’s financial affairs, instead of the courts.
• Protects against creditors: A trust may provide some spendthrift protections from creditors to beneficiaries after the grantor’s death.
• Flexibility: The grantor can discontinue or change the terms of the trust at any time.

Tax benefits of a revocable living trust

While the grantor is alive, a revocable living trust doesn’t affect their taxes very much. They won’t need to obtain a separate tax ID for it, or file a separate tax return. Assets in a trust are reported similarly to how they would be taxed on your client’s individual Form 1040.

However, the day after the grantor dies, the trust becomes “irrevocable,” so the successor trustee will need to obtain a federal tax ID for the trust and begin reporting its taxes. The successor trustee has a financial responsibility to the heirs, and this may include making trades to protect assets from market volatility. This means that the trust may realize capital gains or losses, which are reported on Form 1041, U.S. Income Tax Return for Estates and Trusts.

One of the primary tax advantages of a living trust is a “step up” in cost basis when the grantor passes away. When this occurs, if the value of the assets in the trust is more than they were acquired for, the assets’ cost basis increases to its fair market value on the day the grantor died. This minimizes capital gains taxes for heirs.

For example, at the time of Sally’s death, she was holding one Bitcoin (BTC) that had been purchased for $10,000, but was currently valued at $30,000. Two months later, when the estate was settled, BTC was valued at $32,000.

Without the step up in cost basis provided by a trust, Sally’s heirs would realize $22,000 of capital gains when they sold BTC. However, with the step up to the value on the date of death, they would only have $2,000 of long-term capital gains.

Please note that all “inherited” assets automatically receive long-term capital gains treatment.

Create a pour-over will

With a revocable living trust, it’s still necessary to have a pour-over last will. This document instructs an executor that any of the assets of the deceased that weren’t part of a trust will be automatically transferred to the revocable living trust upon death.

For example, when Paul was setting up his estate, he forgot to include one of his Polygon wallets in the trust. After he dies, it turns out that the Polygon wallet contains an NFT worth $5,000. If Paul didn’t have a pour-over will, it’s possible that the NFT would go through probate. However, with a pour-over will, it would automatically be transferred into the trust at the time of his death, allowing beneficiaries to avoid probate.

A portion of this content originally appeared in “Intro to Crypto Estate Planning” on the TokenTax blog.