In today's rapidly evolving financial landscape, the emergence and adoption of digital assets like Bitcoin and Ethereum have added a layer of complexity to divorce proceedings. Cryptocurrencies and other digital assets present unique challenges in divorce cases, especially when these assets are undisclosed or hidden. In this guide, we will delve into the world of cryptocurrencies, explore their potential for asset hiding, and discuss steps to uncover and equitably distribute digital assets. Get ready to crack the code and learn how to locate and divide digital assets!
What Are Crypto Assets?
Cryptocurrencies, often called “crypto,” encompass a wide range of digital assets. While Bitcoin is the most well-known, “crypto” also includes other digital value representations, such as utility and non-fungible tokens (NFTs). Utility tokens grant access to specific platforms or services, while NFTs represent unique digital items, like digital art, collectibles, or virtual real estate. Unlike traditional assets such as real estate or stocks, cryptocurrencies exist only in digital form. This distinction makes them particularly challenging to identify, assess and divide during divorce proceedings.
How Do Cryptocurrencies Enable Asset Hiding?
Cryptocurrencies provide an appealing avenue for asset hiding during divorce due to their unique characteristics. Instant and seamless transferability without traditional intermediaries like banks enables parties to securely transfer and hold digital assets on a computer or smartphone. Moreover, cryptocurrencies operate on decentralized computer networks based on blockchain technology, resulting in a lack of central oversight and making it challenging to monitor financial activities. Additionally, cryptocurrency transactions are pseudonymous, meaning the real identity behind each transaction is often obscured, adding a layer of privacy and confidentiality.
Like traditional brokerages, “exchanges” serve as digital platforms that enable individuals to trade, buy, and sell cryptocurrencies. Users can deposit funds, usually in fiat currency or other cryptocurrencies, into accounts on the exchange platform and use those funds to purchase or sell different cryptocurrencies at prevailing market prices. Exchanges provide user-friendly interfaces, order books displaying current buy and sell orders, and often offer additional features such as advanced trading options, secure storage of funds, and access to market data.
Fortunately, transactions on exchanges can leave traces crucial in uncovering hidden cryptocurrency assets. Family law attorneys can request transaction records from these exchanges as part of the discovery process to unveil the existence and location of potential hidden assets.
Several well-established cryptocurrency exchanges have gained prominence in the crypto industry. Notable examples include Binance, Coinbase, Kraken, Gemini, Bitfinex, and KuCoin. However, it's important to note that the cryptocurrency exchange landscape is dynamic, with new and existing exchanges evolving.
Digital Wallets: Where Crypto Assets Reside
Digital wallets are tools that store, send, and receive cryptocurrencies. They come in various forms, including software wallets (online or mobile apps), hardware wallets (physical devices), and paper wallets (printed or written codes). Cryptocurrency holdings can be stored off exchanges in digital wallets, protected by complex cryptographic keys, making it difficult to link these assets to an individual.
A digital wallet typically consists of a pair of cryptographic keys. The public key, also known as the address, is used for sending and receiving funds, while the private key, acting as a password, is utilized for authorizing transactions and accessing the stored assets. Safeguarding and protecting the private key is crucial to ensure the security of cryptocurrency holdings.
Identifying Signs of Hidden Cryptocurrency Assets
Recognizing indicators of hidden cryptocurrency assets is crucial for family law attorneys. Unusual financial behavior, such as unexplained transfers or discrepancies in reported income, may signal attempts to hide assets using cryptocurrencies. There are indicators, or signs individuals should be aware of if they suspect their spouse is hiding cryptocurrency assets during a divorce. Here are some examples:
- Cryptocurrency Wallets: Look for evidence of cryptocurrency wallets on electronic devices or statements related to wallet services. Wallets may be stored on computers, smartphones as an app, or hardware devices. Unexplained transfers of funds to or from cryptocurrency wallets can be a strong indication of hidden assets.
- Unfamiliar Financial Accounts: Monitor bank statements and financial records for unusual transactions or transfers to cryptocurrency exchanges or platforms. These transactions can suggest the conversion of funds into cryptocurrencies or moving assets to different exchanges.
- Increased Online Security Measures: A sudden increase in security measures, such as using encrypted messaging apps, password managers, or virtual private networks (VPNs), may signify attempts to conceal cryptocurrency-related activities.
- Minimal Financial Footprint: If your spouse's financial records or bank statements show a lack of transactions or a significant decrease in traditional financial activity or spending, it may indicate the presence of hidden cryptocurrency assets. However, this can also suggest that a spouse has other undisclosed traditional accounts like checking accounts.
- Unreported Income or Investments: Look for discrepancies between reported income and actual spending patterns. If your spouse is living beyond their reported means or making substantial purchases without a clear source of income, it could suggest hidden cryptocurrency assets.
- Unexplained Tech Expertise: If your spouse suddenly exhibits a high level of technical knowledge or is interested in computer programming, cryptography, or blockchain technology, it could indicate involvement with cryptocurrencies.
Where to Look
Uncovering hidden cryptocurrency assets requires a strategic approach. Family law attorneys should collaborate with forensic experts and technology specialists who can analyze financial records, trace transactions, and identify digital breadcrumbs left behind by cryptocurrency transactions. In-depth investigations can shed light on concealed assets and contribute to achieving an equitable distribution. If you suspect a spouse is hiding assets, you must actively search for proof of your suspicions. Places to start include:
Bank and Credit Statements
Cryptocurrency is usually purchased with fiat (currency), so at some point, money must move from a bank account into a cryptocurrency exchange account. It is, therefore, essential to check bank and credit card statements for popular crypto exchange names such as Coinbase, Binance, Kraken, Bitfinex, Gemini, KuCoin, Etoro, and Bitstamp. In addition, look for purchases or transfers with descriptions such as “crypto”, “coin”, “digital asset”, or ticker symbols like BTC (Bitcoin), ETH (Ethereum), LTC (Litecoin), ADA (Cardano), XLM (Stellar), and DOGE (Dogecoin). If you see evidence of any crypto activity, however insignificant, it's worth investigating further — especially if a spouse omitted these assets from their initial disclosures.
App-Sleuthing: Revealing Crypto Clues!
Evidence of crypto use may be hiding in plain sight. Look for crypto-related apps installed on phones, tablets, and other electronic devices, such as:
- Exchange Apps: These apps enable users to trade cryptocurrencies and access market data. Popular exchange apps include Coinbase, Binance, and Kraken.
- Payment Apps: These apps facilitate cryptocurrency payments and transactions. Notable examples are Strike, BitPay, Crypto.com, and Venmo (which supports cryptocurrency transactions).
- Price Tracking Apps: These apps provide real-time price updates and market information for various cryptocurrencies. Examples include CoinMarketCap, CoinGecko, and Blockfolio.
- Wallet Apps: These apps allow users to manage their cryptocurrency holdings, send and receive funds, and view transaction history. Examples include Ledger, Trezor, Coinbase Wallet, Trust Wallet, and Exodus.
- News and Information Apps: These apps offer news, articles, and educational resources related to cryptocurrencies and blockchain technology. Examples include CoinDesk, Cointelegraph, and CryptoSlate.
- Twitter & Reddit Feeds: Check who your spouse follows on Twitter and Reddit. Check hashtag searches for cryptocurrency. An interest in hashtags like #Bitcoin, #BTC, #ETH, or #Crypto shows at least an interest in these assets.
Checking if your spouse has reported crypto on a tax return is vital. Income from cryptocurrency transactions is taxable by law, just like income or gains from other property. Starting in tax year 2019, the IRS began to include 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.” IRS introduced this question to improve tax compliance and ensure taxpayers accurately report their cryptocurrency-related income and gains. If this box is checked on a tax return, the details of each transaction must be reported on Form 8949 (Sales and Other Dispositions of Capital Assets).
Other places to look for evidence of crypto assets include loan applications. Even if a spouse is trying to hide crypto assets, they might still list them on a loan or line of credit application. After all, you want your balance sheet to look good if you're trying to secure a loan!
What Should You Do if You Suspect Your Spouse Is Hiding Cryptocurrency Assets?
If you suspect your spouse is hiding cryptocurrency assets during divorce, taking proactive steps to protect your financial interests is crucial. Here are some actions to consider:
- Consult with an Experienced Divorce Attorney: Seek the guidance of a divorce attorney with knowledge and experience handling cases involving cryptocurrency assets. They can provide legal advice, guide you through the process, and assist in effectively uncovering and addressing hidden assets.
- Gather Evidence: Document any suspicious behavior or financial activities that raise concerns about hidden cryptocurrency assets. Keep records of unexplained expenses, withdrawals, or transfers. Take screenshots or save relevant digital communications or financial statements that may serve as evidence.
- Pursue Extensive Discovery: Obtaining complete financial disclosure from the spouse is critical. Work with your attorney to utilize legal tools such as subpoenas, formal discovery requests, or court orders to compel your spouse to disclose information about their financial holdings, including cryptocurrency assets.
- Consult Financial and Cryptocurrency Experts: Engage the services of forensic accountants or cryptocurrency experts who can help identify and evaluate hidden cryptocurrency assets. They can analyze blockchain transactions, trace digital wallets, and provide expert opinions on the value of the assets.
- Consider Mediation or Arbitration: If you and your spouse are open to alternative dispute resolution methods, such as mediation or arbitration, consider working with a mediator who understands cryptocurrencies and can facilitate discussions on the division of assets. A knowledgeable mediator can help the parties reach a fair and equitable resolution.
Valuing Cryptocurrency During Divorce
Divorcing couples often face the challenge of fairly dividing their assets, but the complexity is magnified when cryptocurrency enters the equation. Cryptocurrencies are highly volatile and can experience significant price fluctuations quickly. Determining an accurate and fair valuation is essential to ensure an equitable distribution of marital property.
Crypto assets are property. Like other assets, crypto may be deemed community property subject to division in a divorce action. Dividing cryptocurrency or its equivalent worth can be difficult, as it is not only easy for parties to hide cryptocurrency transactions, but it can also be challenging to determine the actual value of cryptocurrency.
Challenges of Valuing Cryptocurrency
Market Volatility: Cryptocurrency markets are known for their extreme volatility. The value of cryptocurrencies can skyrocket or plummet within hours, making it challenging to pinpoint a precise valuation at any given moment.
Lack of Regulation: The lack of regulatory oversight in the cryptocurrency space further complicates valuation. Unlike traditional assets that adhere to established valuation standards, cryptocurrencies operate in a relatively unregulated environment.
Multiple Exchanges: Cryptocurrencies are traded on numerous exchanges, each with potentially varying prices for the same digital asset. This divergence can lead to discrepancies in valuation if not carefully addressed.
Valuation Methods for Cryptocurrency
Market Value: This method involves valuing cryptocurrency assets based on current market prices. While it provides a real-time snapshot of value, it may not accurately reflect the long-term worth of the assets due to market fluctuations.
Cost Basis: Calculating the cost basis involves determining the original purchase price of the cryptocurrency. While it offers a historical perspective, it may not consider the current market conditions.
Expert Appraisal: Engaging a cryptocurrency valuation expert may be necessary for complex cryptocurrency portfolios. These professionals analyze various factors, including historical data, market trends, and the specific cryptocurrencies held.
Approaches to Addressing the Valuation Challenge
Evaluating the average value: Instead of considering the peak value or the current reduced value of the crypto asset, the parties can agree to use an average value over a specific period of time. This approach aims to provide a more balanced representation of the asset's worth, considering both the peak and lower market values.
Offsetting other assets: If one spouse incurred significant losses due to the decreased value of the crypto asset, the parties may consider offsetting losses by adjusting the division of other assets. This can help balance the impact of the volatile cryptocurrency market on the overall distribution of marital property.
Deferred settlements: In some cases, deferring the sale or transfer of cryptocurrency assets may be beneficial until the market stabilizes or recovers. This approach allows both parties to hold onto their respective shares of the assets without realizing immediate losses. It provides an opportunity to benefit from potential future market improvements.
In-Kind Division: In-kind division refers to directly transferring specific cryptocurrencies from one spouse to another rather than selling the assets and splitting the proceeds. Like issues with an in-kind division of other securities such as stocks or bonds, when dealing with a cryptocurrency, which is subject to significant price fluctuations, determining an equitable division becomes more complex. Both parties must agree on the valuation date and method to assess the asset's value accurately. Additionally, considering the tax implications of such transfers is crucial, as the recipient may inherit the tax basis and potential capital gains or losses associated with the cryptocurrency.
Dividing Cryptocurrency in a Divorce
Husband and Wife are going through a divorce. It is discovered that Husband has significant Bitcoin holdings held in an electronic wallet in Husband's name. Husband and Wife need to decide how to divide the community Bitcoin holdings. They have three main options: transfer, cash-out, or valuing for offset. Let's look at all three.
If a portion (or all) of the Bitcoin holdings will be transferred to Wife, she must open an electronic wallet to receive the transfer. Husband will need Wife's new wallet address for the Bitcoin to make the transfer. Husband can then send the Bitcoin to Wife based on a dollar value or by selecting the number of coins to send.
Important Considerations About Crypto Transfers
- Is the spouse comfortable with the complexity and risks associated with the custody and potential volatility of crypto?
- Who will cover transaction fees related to the transfer?
- What is the impact of potential capital gains or losses on the digital assets received?
One thing to remember is Internal Revenue Code Section 1041, which states that property transfers between spouses or incident to divorce are treated as a gift and are not taxable at the time of transfer. Under this rule, the transferee acquires the transferor's tax basis in the property. The effect is to defer tax consequences (recognition of any gain or loss) until the transferee disposes of the property. Consulting a competent tax advisor on these issues is always wise!
Wife decides 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 options one and two is in whose name the capital gains must be reported. And, in the case of a crypto transfer, there will likely be transaction fees that should be considered.
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 include:
- What value will be 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 different from $10,000 in cryptocurrency purchased for $3,000. The cryptocurrency in this example would have a $7,000 taxable capital gain if sold or transferred for goods or services. The spouse who keeps the cryptocurrency should consider asking for a full or partial tax discount to help cover future taxes.
Every divorce involving cryptocurrency assets is unique, requiring tailored strategies based on individual circumstances. Working closely with a knowledgeable divorce attorney experienced in complex financial matters is crucial to protecting one's interests. When it's time to mediate, leveraging the expertise of a mediator who understands cryptocurrencies, trading exchanges, and blockchain technology becomes even more critical.
At Armatys Millard, we understand the intricacies of divorce cases involving hidden assets, including cryptocurrencies. With our expertise in family law and judicial insight, we can guide you through mediation or arbitration toward a successful resolution. Schedule your mediation session today and take the first step toward a fair and equitable divorce settlement.
Ready to Take a Deeper Dive?
As you have probably gleaned, the topic of digital assets is complex and evolving. One thing is certain – digital assets are here to stay, and their importance in the division of the marital estate will continue to escalate. As family law practitioners, we must become educated about these assets. This article provides only a brief overview of this complicated subject. If you're ready to learn more, I suggest that you consider reading the following excellent articles:
A Divorce Practitioner's Bitcoin Primer, by Richard West and Jonathan Fields.