Cryptocurrency has emerged as a significant and sometimes perplexing asset in modern divorce proceedings. For attorneys and their clients, understanding how to identify, value, and divide cryptocurrency is essential to achieving a fair resolution. A Certified Divorce Financial Analyst will walk through the fundamentals of cryptocurrency, provide examples of popular coins, discuss how courts treat digital assets, outline potential tax and income impacts, and highlight relevant case law below.
What Is Cryptocurrency?
Cryptocurrency is a form of digital or virtual currency that uses cryptography for security. Unlike traditional currencies issued by governments (so-called “fiat” currencies), cryptocurrencies operate on decentralized networks based on blockchain technology, which is essentially a digital ledger recording transactions across multiple computers.
The most well-known cryptocurrency is Bitcoin (BTC), but thousands of other coins exist, each with unique features and uses. Some of the most prominent include:
- Bitcoin (BTC): The original and most widely traded digital currency, known for its decentralized nature and capped supply.
- Ethereum (ETH): A blockchain platform with its own currency (Ether), notable for enabling smart contracts and decentralized applications.
- Ripple (XRP): Designed for fast, low-cost international payments, often used by financial institutions.
- Litecoin (LTC): A peer-to-peer cryptocurrency created as a “lighter” version of Bitcoin, with faster transaction times.
- Dogecoin (DOGE): Initially started as a joke, it’s gained popularity for microtransactions and tipping online.
Cryptocurrency may be held in digital wallets, on exchanges, or even in “cold storage” (offline devices), making it highly portable and sometimes difficult to trace.
Is Cryptocurrency Treated As An Asset In Divorce?
In divorce proceedings, cryptocurrency is treated as property or an asset, much like stocks, bonds, or real estate. Most family law courts consider cryptocurrency acquired during the marriage to be marital property, subject to division under the relevant state’s laws whether that’s equitable distribution or community property.
The legal treatment of cryptocurrency as an asset means both parties must disclose their holdings during the discovery phase. Hiding or failing to disclose cryptocurrency can have serious legal consequences, including sanctions and altered division outcomes.
Valuing Cryptocurrency In Divorce
Valuing cryptocurrency can be complicated due to its volatile nature and the diversity of coins and tokens. Attorneys must consider several key issues:
- Market Volatility: Cryptocurrency prices can change dramatically in a short period, so the timing of valuation is crucial. Courts may use the date of separation, date of trial, or another agreed-upon date.
- Accessibility: Determining whether either party has access to digital wallets, exchanges, or passwords can impact both valuation and division.
- Traceability: Some cryptocurrencies prioritize privacy, making forensic investigation important but difficult to determine holdings.
How Financial Experts Help
Engaging a financial expert is often essential to property division involving cryptocurrency. Financial experts, particularly forensic accountants with digital asset experience, are invaluable in these situations. As our friends at Baron Analytics can explain, financial experts assist with tracing assets, providing current and historical valuations, and testifying about the methodology used for appraisals.
These experts can:
- Identify all cryptocurrency holdings, including coins held in obscure wallets or exchanges.
- Analyze transaction histories and wallet addresses to verify ownership and value.
- Provide reliable appraisals based on the most accurate data available at the time of valuation.
- Offer expert testimony if questions about asset division or value arise in court.
Their input can help avoid costly mistakes and ensure neither party is unfairly advantaged or disadvantaged.
Tax Liabilities Associated With Cryptocurrency
Cryptocurrency can carry significant tax consequences, both during and after divorce. The true value of cryptocurrency should recognize tax liabilities, especially when compared to fully taxed assets such as cash. The IRS treats cryptocurrency as property, not currency, for tax purposes, which means that selling, converting, or transferring digital assets can trigger capital gains taxes.
- Division Of Assets: Transferring cryptocurrency between spouses as part of a divorce settlement doesn’t generally incur taxes at the time of transfer. However, a subsequent sale or conversion can result in taxable gains or losses.
- Reporting Requirements: Both parties must accurately report gains or losses to the IRS. Failure to do so can result in audits or penalties.
- Valuation Date: Determining the cost basis and fair market value at the time of acquisition and transfer is crucial for future tax reporting.
Tax Issues In Divorce Involving Cryptocurrency
While few reported cases directly address cryptocurrency taxation in divorce, parallels can be drawn from cases involving other complex assets. In United States v. Zaslavskiy, 2019 WL 103596, the court found that digital assets are subject to existing property and tax laws, including reporting requirements.
Practitioners should advise clients to consult with a tax professional before finalizing divorce settlements involving cryptocurrency.
Impact Of Cryptocurrency On Income And Support Calculations
Cryptocurrency holdings may affect alimony and child support calculations in two ways:
- Income Generation: If one party earns income from trading or mining cryptocurrency, that income must be disclosed and factored into support obligations.
- Asset Division Affecting Financial Resources: The division of cryptocurrency assets can alter each party’s overall financial position, influencing both spousal and child support awards.
Courts will typically look at recent transaction histories and account balances to determine whether cryptocurrency should be considered as income or merely as a marital asset.
Best Practices For Attorneys
Attorneys handling divorces involving cryptocurrency should adopt a thorough and systematic approach:
- Request full disclosure of all digital asset holdings during discovery.
- Engage forensic experts to trace and value cryptocurrencies where necessary.
- Consult with tax advisors regarding potential tax liabilities and reporting requirements.
- Communicate clearly with clients about the risks, volatility, and legal obligations associated with digital assets.
- Stay abreast of emerging case law and statutory developments regarding digital assets in family law.
Cryptocurrency adds new complexity to divorce proceedings, requiring both legal and technical expertise. Its status as marital property is well established in case law, but valuation and division present unique challenges. Market volatility, traceability, and tax consequences can complicate settlements, making it essential to involve financial experts and tax professionals. By taking a proactive, transparent, and informed approach, attorneys can help clients achieve fair and equitable outcomes that account for the full value and potential of digital assets.
If you’re facing a divorce involving cryptocurrency, seek out a family law attorney experienced in digital asset division and don’t hesitate to bring on financial experts.
