What Is the Cost Basis of Inherited Virtual Currency?

Virtual currency is an important asset in estate planning and inheritance. Understanding the cost basis of these digital assets upon inheritance is important for beneficiaries. Determining cost basis ensures compliance and impacts the inheritor’s financial outcome.

Understanding Cost Basis for Inherited Virtual Currency

Cost basis is an asset’s original value for tax purposes, used to determine capital gains or losses. For inherited property, including virtual currency, the “step-up in basis” rule applies. Internal Revenue Code Section 1014 states the basis of property acquired from a decedent is its fair market value (FMV) on the date of death.

This step-up in basis is beneficial for beneficiaries. If the decedent acquired virtual currency at a low price, the inheritor’s cost basis “steps up” to its market value at inheritance, rather than the original purchase price. This adjustment can reduce taxable capital gains or result in a capital loss. For example, if virtual currency bought for $100 is worth $10,000 at death, the beneficiary’s new cost basis becomes $10,000, not $100.

The step-up in basis rule treats inherited virtual currency like other capital assets (e.g., stocks, real estate), simplifying tax implications for beneficiaries. It prevents taxation on appreciation during the decedent’s lifetime. Understanding this principle is important before any transactions.

Valuing Inherited Virtual Currency at Inheritance

Determining the fair market value (FMV) of inherited virtual currency on the date of death is important for its cost basis. This date aligns with ownership transfer. Virtual currency prices fluctuate significantly, making precise valuation challenging but necessary for tax compliance.

FMV is established using the average of highest and lowest trading prices on major virtual currency exchanges. Reputable exchanges and aggregators (e.g., CoinMarketCap, CoinGecko) provide historical data. Blockchain explorers offer transaction details and wallet balances to confirm holdings.

An alternative valuation date may be elected under Internal Revenue Code Section 2032. This allows the executor to value assets six months after death, but only if the gross estate’s value and estate tax liability are lower than the date of death value. This election is uncommon and applies to all estate assets, not just virtual currency. The chosen method must be consistently applied and documented for tax authority scrutiny.

Valuing less liquid or obscure virtual currencies is challenging due to limited trading data. An independent appraisal from a qualified virtual asset valuation professional may be advisable. This ensures the FMV is reasonable and defensible, providing a strong foundation. Without a clear valuation, future tax calculations can be problematic.

Calculating Capital Gains or Losses

Once inherited virtual currency’s cost basis is established, calculating capital gains or losses upon disposition is clear. The formula is the sale price minus its determined cost basis. If the sale price exceeds the cost basis, a capital gain results; if less, a capital loss is incurred.

Inherited assets, including virtual currency, receive an automatic long-term holding period. Internal Revenue Code Section 1223 states inherited property is held for over one year, regardless of the beneficiary’s or decedent’s actual holding period. This means capital gains from inherited virtual currency sales are subject to more favorable long-term capital gains tax rates.

For instance, if inherited virtual currency with a $10,000 cost basis sells for $12,000, a $2,000 long-term capital gain is realized. If sold for $8,000, a $2,000 long-term capital loss is incurred. Long-term capital gains tax rates are lower than ordinary income tax rates, often ranging from 0% to 20% depending on taxable income.

Understanding the difference between long-term and short-term capital gains is important; short-term gains (assets held under one year) are taxed at ordinary income rates, which can be much higher. The automatic long-term classification for inherited virtual currency provides a tax benefit. This distinction allows beneficiaries to plan dispositions, knowing the tax treatment.

Record Keeping and Tax Reporting

Accurate records are important for beneficiaries to substantiate cost basis and report transactions to the IRS. Documentation helps defend reported figures in an audit. These records should be retained for at least three years from the date the tax return was filed, or longer if there is unreported income.

Essential documents include the decedent’s death certificate, probate documents, and estate tax returns (Form 706). Documentation supporting the fair market value for the step-up in basis (e.g., exchange printouts, appraisal reports) should also be kept. Transaction histories detailing the sale or disposition are necessary.

Capital gains and losses from virtual currency sales are reported on Form 8949. Form 8949 information is summarized on Schedule D, filed with Form 1040. On Form 8949, the acquisition date for inherited property is entered as “VARIOUS” or “INHERITED” to reflect the automatic long-term holding period; the cost basis is the fair market value on the date of death.

Accurate record-keeping simplifies tax filing and minimizes errors. Without proper documentation, proving the stepped-up cost basis can be challenging, potentially leading to higher tax liability. Organizing and storing all relevant information from inheritance through disposition is important for the beneficiary.