With the rise in popularity of cryptocurrency over the past few years, it is becoming a hot topic in many divorce cases.
In this guide, I’m going to give you a high-level overview of cryptocurrency and explain your options on how to deal with it in a divorce.
Here is what you need to know.
- The basics of cryptocurrency
- Cryptocurrency and taxes
- Understanding the basics of cryptocurrency in a divorce
- How to value or divide cryptocurrency in a divorce
- How to tell if my spouse is hiding crypto currency and how to find
- Cryptocurrency FAQs
The Basics of Cryptocurrency
In an asset class of its own, cryptocurrency is a virtual or digital currency that can be used like real money as a medium of exchange.
It is not a physical token, like a dollar bill, but is similar to an electronic payment system (think of swiping your credit card) as a way to pay for something.
Cryptocurrency “coins” are held in a digital wallet, which can be an online service, a software program, or a personal hard drive among other things.
The wallet allows the owner to make secure transactions for goods and services or keep it as a type of investment.
Since the coins are not issued by a central authority, like a bank or government, they are theoretically immune to inflation and other government interference.
Cryptocurrency and Taxes
Currently, cryptocurrency holdings are considered property and therefore are taxed at capital gains rates.
You would incur a gain or loss when sold, transferred as payment for goods or services, exchanged with another crypto, and at other various scenarios.
You are required by the IRS to report gains and losses on each transaction even if the gain or loss is not material.
The difference between the purchase price and sales/transfer price is what will be taxed.
If the value at the time of sale or transfer is more than the purchase price, you will incur a capital gain.
If the value at the time of sale or transfer is less than the purchase price, you will incur a capital loss.
In the past, cryptocurrency has been a way for individuals to avoid taxes and the IRS is starting to crackdown on that.
Recently, the IRS included a question on the front page of the federal tax return 1040 form asking if “you received, sold, sent, exchanged, or otherwise acquired any financial interest in any virtual currency.”
Per the IRS, if you purchased cryptocurrency with cash, and that was your only transaction, you would answer no to this question. Any other transactions, the answer would be yes.
HOT TIP: Not sure where to view the transactions related to your cryptocurrency to see if you owe taxes? The ledger in your digital wallet keeps track of all transfers, purchases and sales that took place in your account. Start here to see if you need to report anything on your tax return.
Understanding the Basics of Cryptocurrency in a Divorce
Cryptocurrency is considered an asset, not income, and should be listed on your financial disclosures when you are going through the divorce process.
Most cryptocurrency holdings have a current value which is listed when you log into your account. The values listed are based on current exchange rates for that specific cryptocurrency to US dollars.
However, values can fluctuate by a significant amount daily so it is important to keep this into consideration when using the value listed on the financial disclosures when dividing property.
How to Determine the Marital (Community) Portion of Cryptocurrency in a Divorce
Property division laws vary from state to state.
The vast majority of states are equitable distribution states where assets are divided fairly but not always equally.
How to Value or Divide Cryptocurrency in a Divorce
Husband and Wife are going through a divorce and need to decide what to do with their Bitcoin which is held in an electronic wallet in Husband’s name.
They have three main options: transfer, cash-out, or valuing for offset.
Let’s look at all three.
Wife will need to open an electronic wallet so she can receive the transfer for her portion of the Bitcoin.
Husband will need Wife’s wallet address for the Bitcoin. Note that each cryptocurrency holding will have a different wallet address.
Husband can then send the Bitcoin to Wife either based on a US dollar value or by selecting an amount of the coin to send.
Things to consider if you go the transfer route
- Is Wife comfortable with the risk level and potential volatility of Bitcoin?
- Determine who will cover the fees.
- It is important to keep records for future tax implications.
HOT TIP: Most cryptocurrency exchanges don’t have a way of coding a transfer as “incident to divorce” and may code it as a disposition instead. Both parties should keep detailed records of the transfer to avoid a tax headache later down the road. A copy of the ledger from the transferor’s wallet is a good place to start.
Keep in mind: Internal Revenue Code Section 1041 states that transfers of property between spouses or incident to divorce is treated as a gift and is not a taxable event.
Wife decides that she doesn’t want to deal with the volatile nature of their marital cryptocurrency holdings and would prefer to sell her portion of the Bitcoin and receive cash instead.
There are two ways to do this.
Option 1: Husband sells Wife’s portion and sends Wife the cash.
Option 2: Husband sends Wife her portion of the cryptocurrency and Wife sells it immediately and receives the cash.
Things to consider if you go the cash-out route
- The main difference between option 1 and option 2 is whose name the capital gains will need to be reported under.
- Determine who will cover the fees.
Valuing for offset
Wife decides she would prefer an offset for the value of her portion of the cryptocurrency.
This means a value needs to be placed on the Bitcoin that Husband is keeping and Wife will receive another asset instead.
Things to consider if you go the “Value for Offset” route
- What value is used? Due to the wide fluctuations in the market value of some cryptocurrencies, it may make sense to not determine the offset value until the date the divorce is finalized or close to it. Another option would be to use a 52-week moving average as the value.
- Are tax consequences considered when determining a value for offset? For example, $10,000 in cash is not the same as $10,000 in cryptocurrency that was purchased for $3,000. The cryptocurrency in this example would have a $7,000 taxable capital gain if it were sold or transferred for goods or services. The spouse who keeps the cryptocurrency could think about asking for a full or partial tax discount in this situation to help cover future taxes.
So far, we have talked about transferring, cashing out, or valuing cryptocurrency for an offset.
There is no right way to go about what to do with marital cryptocurrency and it will depend on you and your spouse’s personal preference.
Risk tolerance, type of cryptocurrency, and tax consequences are all things to consider.
It is also not all or nothing. You could consider doing a partial cash-out and a partial buyout depending on what works best for you.
And as a reminder, keeping detailed records is VERY important.
How to Tell if My Spouse is Hiding Cryptocurrency and How to Find it
Did you see evidence of cryptocurrency during your marriage that your spouse didn’t list on their financial disclosures?
Cryptocurrency is hard to trace, which is one of the factors that makes it so appealing to some, but that doesn’t mean you can’t find evidence that it exists.
Tips to locate cryptocurrency that you think your spouse is hiding
Tip 1: Look for wires or other transfers leaving your bank accounts.
If you had a joint bank account with your spouse, it is common for each party on a bank account to get an email or notification when money is wired or transferred out of the account.
Try to find the emails that show where the funds are being transferred to. Under the “Transfer Details” section of the email, it should say where the funds went.
If you don’t recognize where the funds were transferred, do a quick internet search.
If you find an email from your bank that shows money being transferred to a cryptocurrency exchange, save the email and note the following:
- Where the money was transferred to
- Date of the wire or transfer
- Amount of money that was transferred out.
You could also scroll through your online banking history to see if you notice any unusual transfers going in or out.
If you see evidence of this, a forensic accountant can review transaction details to trace money going in and out of your accounts.
Hot Tip: This could also include large purchases going through Paypal, venmo, or cash app. These online platforms also allow you to purchase cryptocurrency through them.
Tip 2: Emails from a cryptocurrency platform.
Everytime cryptocurrency is purchased or funds are transferred into an electronic wallet an email is sent to the owner of the wallet letting them know some sort of transaction has occurred.
If you have seen this type of email, it may be worth mentioning to your attorney or asking your spouse about it.
It is important that if you find emails that you don’t delete them and save them in another area so they don’t get lost.
Tip 3: Have you discussed cryptocurrency with your spouse?
If you and your spouse have talked about cryptocurrency in the past and you know it exists, try to recall the details around that conversation and the date you discussed it. Can you find a corresponding bank transaction around the same time?
Tip 4: Check your tax returns.
You are required to report most cryptocurrency transactions on your tax return.
If cryptocurrency was sold or transferred and a capital gain or loss was incurred, this would show up on your tax returns in the following places:
- Schedule D (Form 1040) – Capital Gains and Losses – this form shows the amount of gains/losses for the tax year.
- Form 8949 – Sales and Other Dispositions of Capital Assets – this form gives a description of the property that was sold, the date it was sold, and the gains/losses associated with the sale.
Keep in mind that if you or your spouse purchased cryptocurrency with cash and held onto it, this would not need to be reported on your tax return.
Tip 5: Cryptocurrency wallets can be USB drives or external hard drives.
Some cryptocurrency isn’t held in an online exchange. Instead it is stored on a USB drive or an external hard drive. If you have noticed either of these lying around the house and can’t find any other proof of the cryptocurrency, this may be where it is stored.
Tip 6: Last resort – have your divorce attorney Subpoena computers, and other electronics
Hopefully it doesn’t come to this, but if you are sure your spouse is hiding cryptocurrency it may be best to have your spouse’s electronics subpoenaed.
A forensic specialist can sort through the information on the computer and see if there is any evidence of cryptocurrency on it.
This will likely be a fairly expensive process and therefore a cost/benefit analysis may need to be performed to see if it is worth it.
Most Frequently Asked Questions about Cryptocurrency
What is blockchain?
Blockchain is an open database that securely stores cryptocurrency over multiple computers.
The blockchain keeps track of all cryptocurrency transactions which are permanently recorded on a distributed ledger which can not be altered in any way.
Cryptography, the art of writing or solving codes, keeps the ledger secure so hackers are unable to forge coins.
Types of cryptocurrency
There are currently thousands of different types of cryptocurrency. Here is a list of some of the popular ones:
- Bitcoin Cash
What determines the value of cryptocurrency?
Some cryptocurrencies have an exchange rate with US dollars so the value can be easily determined.
Others do not and if a value is needed, a financial expert may need to determine the one for you.
Unlike a fiat currency (i.e. the US dollar), which is issued and controlled by a government, cryptocurrencies’ value isn’t related to a government’s monetary policy.
What causes the value to go up and down?
Supply and demand is one of the leading factors that causes the value of certain cryptocurrencies to rise and fall.
Just like real currencies, most don’t generate cash flow on their own. For you to profit, someone has to pay more for the cryptocurrency than you did.
Recently, social media posts by celebrities discussing specific cryptocurrencies have also caused values to fluctuate significantly.
How do you purchase cryptocurrency?
There are many online platforms, or cryptocurrency exchanges, that allow you to buy, sell, and exchange cryptocurrency. Some popular ones are:
- Cash App
Once you set up an account with any of the exchanges, you will need to fund your account with cash. You can do this by attaching your bank account, sending a wire transfer, paypal, etc.
When the cash is deposited into your account, you are able to purchase cryptocurrency. The value of your cryptocurrency will be based on the current exchange rate and your purchase will be held in your digital wallet.
What is a ledger and what details are shown on a ledger?
A ledger is a record keeping system within a digital wallet or online account.
It contains the following details:
- Transaction ID
- Date and time of transaction
- Type of transaction
- Currency used in transaction
- Associated fee
What specific records should I keep track of for my cryptocurrency?
Reviewing the ledger is a great way to keep track of your crypto details. If you are receiving it as part of the divorce, keep detailed records of the following:
- Original purchase price
- Original date of purchase
- Transfer date
- Associated purchase/transfer fees
Can you earn interest or dividends from cryptocurrency?
Yes, some cryptocurrencies pay out dividends. Additionally, a number of companies offer “cryptocurrency savings accounts” where, like a regular savings account, you can receive an interest payment.
What information do you need to obtain for cryptocurrency in a divorce?
- A screenshot/statement that shows all the cryptocurrency holdings and their values.
- Purchase dates for all holdings.
- Purchase price for all holdings.
- Export of the ledger which shows details on all sales, purchases, deposits, and transfers.
The owner of the account will need to pull these details.