When we assist clients in estate planning (e.g., often including the preparation of a last will and testament, a representation agreement, an inter vivos trust, and an enduring power of attorney), many questions arise and many issues need to be considered. Certainly, there is the initial question of ownership of assets and liabilities, control and management of funds and accounts, payment of tax and ultimately, the distribution of estates.
Over the last few years, the question of non-fungible tokens (“NFTs”) has been getting considerable attention, and is more frequently presenting as an estate planning issue for our clients. In this article, we will look at NFTs, the issues that they create in an estate plan, and how to effectively deal with them. This article will use the FAQ approach, to provide you with information and background to assist you in understanding NFTs, and how best to deal with them in a properly prepared estate plan.
[If you want a glossary of NFT related terms, click here)
What is a non-fungible token?
A non-fungible token or NFT, is an electronic asset that is uniquely identified. It is non-fungible, meaning that each NFT is distinguishable from all other NFTs. That is to say, that no two are the same (i.e., like snowflakes or fine art). Additionally, an NFT is a digital token, rather than a physical token like a casino chip or a share certificate. By comparison, cryptocurrency like Bitcoins are fungible tokens, in that every Bitcoin is the same as every other Bitcoin.
What do NFTs represent?
NFTs may represent photographs, videos, music, artwork, on-line gaming content, tweets, and other types of digital files. They are electronic representations (tokens) of this property compared to a physical token like a casino chip that represents a specific number of physical dollars. Unless specifically included, the NFT does not encompass the underlying intellectual property, such as the copyright for the work the NFT represents.
Where are NFTs stored?
NFTs are stored on a blockchain that certifies that the digital asset is unique and not interchangeable with another asset. A blockchain is a distributed database, often referred to as the ledger, that is, a list of transactions and their details such as the date and time of the transaction, which is held by individuals who agree to share the database with all other users of the same database. The database is then continuously updated and synchronized. This results in all users having the complete record of the NFT transactions, instead of having only one central computer or entity that processes all transactions. Each transaction or block is added to the chain along with a timestamp and link to the previous block. These transactions immediately revise all of the other copies of the database. This results in a record that is virtually impossible to hack.
How does a person create an NFT?
The creation process of an NFT is called “minting.” NFTs are minted on a blockchain in a similar manner to cryptocurrency. Currently, Ethereum is the most popular platform, but other platforms may also be used. The creator such as an artist, performer, or author links the NFT to the specific item of digital property that it represents. To enhance the value of an NFT, the creator may promise to limit the number of NFTs created. For example, the creator may decide to make only one NFT that represents the digital property or limit creation to a specified limited number (e.g., a series of ten, so purchasers would own 1 of 100, 2 of 100, etc.).
Why does a person create an NFT?
A person creates an NFT in the hopes of selling the NFT to make a profit. Each NFT is unique; no two NFTs are the same. They may not be copied. The name of an owner of an NFT is part of the public blockchain record and thus anyone can verify ownership. NFT creators may sell their work on a global market, as well as retain the right to receive royalties each time the NFT is sold, by using smart contract technology.
What is the value of an NFT?
The value of an NFT depends on market forces (supply and demand), because the NFT has no intrinsic value just like other collectible items. For example, one baseball card may have significant value because it is scarce and highly sought after by collectors, while another card has little or no value because a huge number of the cards are available or the person depicted is not famous.
What are some examples of notable NFTs?
The NFT of Beeple’s (Mike Winkelmann) Everydays: The First 5000 Days, a collage of 5,000 individual pieces created over a 13-year period, sold for $69,346,250 by Christie’s on March 11, 2021. This is said to be the most expensive NFT ever sold and the first by a major auction house.
In the on-line game CryptoKitties, a digital cat sold for $172,000. The game is designed for players to buy, trade, and breed the digital cats. However, the cost is rarely this high. In 2018, the average price paid for a CryptoKitty was $60 with the median price being $9.
An NFT entitled Lebron James: Dunk From the Top sold for $208,000.
Major League Baseball sold a digital copy of Lou Gehrig’s Luckiest Man speech for $70,400 on July 4, 2021.
The swag bag at the recent Oscars included an NFT of Chadwick Boseman, the actor who portrayed the Marvel superhero Black Panther.
An NFT of the first tweet by Jack Dorsey, the co-founder of Twitter, sold for $2.9 million.
Other than collectibles, what are some other possible uses of NFTs?
NFTs could be used to secure and authenticate physical assets, both personal and real property. For example, Nike has patented a system for using NFTs to protect against counterfeit shoes, so subsequent purchasers of high-end sneakers would be certain of their shoes’ authenticity. There is also speculation that NFTs could operate as a highly secure method of transferring title to real property and to store electronic wills and other estate planning documents.
How do NFT owners store and access their NFTs?
NFTs reside in digital “wallets” that can be stored in many different ways such as on an exchange accessed over the Internet, software on a computer, tablet, or cell phone, or on a dedicated flash drive. To be able to retrieve an NFT and transfer it, the person must have the private key or the seed phrase, that is, a list of random words (typically 12, 18 or 24 words) which allows the person to recover the wallet containing the NFT. A seed phrase would look something like this: “sooner broody meat paladin id giantism.” These words are tied to the private key through a complex computation process. The seed phrase needs to be kept secure at all times. Otherwise, anyone with knowledge of the phrase could access the NFT. If the wallet resides on a commercial platform, the NFT may be accessible by a person who knows the user name, password, answers to security questions, and has the ability to satisfy other verification steps.
NFTs and the Estate Plan
It is essential to determine if the client owns or intends to purchase NFTs. We include a question on our client intake questionnaire and in our initial client interview, regarding these types of assets.
What type of records should a client keep about NFTs?
The client must keep careful records of the price paid for each NFT and the price for which it is sold, so that the correct amount of capital gain or loss is reported for tax purposes.
Is there a special concern if the client purchases an NFT with cryptocurrency?
Yes. Many clients will purchase NFTs with cryptocurrency rather than traditional money, which will lead to an additional concern. Cryptocurrency is property, not money. (N.B. In this regard, the Canada Revenue Agency has specifically stated, that cryptocurrency is to be treated as a commodity for income tax purposes and any resulting gains or losses arising from the trading of cryptocurrency will be taxable in the same manner as any other commodity).
Should the client consider holding NFTs in a business entity?
Yes. The client may wish to hold the NFT in an entity such as a corporation. The primary potential advantages include the ease of transfer of the shares of the corporation, compared to transferring the NFT itself, which requires a blockchain transaction.
How should the client protect the information needed to access NFTs?
The private key or seed phrase required to access the digital wallet in which the NFT is stored, must be protected while the client is alive and then transferred to the beneficiary upon the client’s death. Just like cryptocurrency, without the means of accessing the NFT, it will be lost forever. Some clients elect to keep this information in their safety deposit boxes, in old-school written form or on a flash drive or other digital media which may also be encrypted to add another layer of protection. Some people will use complex methods, such as dividing the seed phrase into sections and storing them in different places so that only by bringing them all together like the Infinity Stones can the NFT be accessed. An even more sophisticated method is Shamir Secret Sharing where an algorithm is used to divide the seed phrase into multiple seeds (e.g., five) and the client indicates how many (e.g., 3) need to come together to create the entire seed phrase.
How should a client’s will address NFTs?
The client may make a specific gift of individual NFTs or a general gift of all NFTs the client owns. If NFTs are not specifically mentioned, they will pass under the will’s residuary clause. As discussed previously, it is important to provide a method of transferring the NFT access information to the beneficiary outside of the will. Access information should not be included in the will, because it becomes a public document once filed for probate.
If the client’s NFT collection is extensive, the client may wish to consider appointing a separate “digital executor” who has the responsibility of dealing with digital assets for the benefit of the client’s estate. Even if a separate person is not appointed, the client may wish to direct the executor to hire a person with the skills needed to prudently manage NFTs.
I am a personal representative of a decedent’s estate. Can I access the decedent’s NFTs?
Yes, a personal representative has the authority to access NFTs under the Uniform Access to Digital Assets by Fiduciaries Act 2016 (UADAFA), which provides fiduciaries, or trustees with default access to the Digital Assets of the deceased person. The UADAFA addresses four types of fiduciaries: a personal representative of the deceased’s estate, a guardian appointed for the account holder, an attorney acting under a power of attorney and a trustee. However, the authority to access NFTs is worthless unless the personal representative has the access information.
I am a personal representative of a decedent’s estate. Is there anything special regarding NFTs about which I should be immediately concerned?
Yes, you should document the value of the NFT as of the date of the decedent’s death, and have that information, along with the cost base of the NFTs. There are potentially significant tax implications to the estate, so access to this information, is important.
I am a trustee. Can I retain NFTs in a trust or invest in NFTs?
A trustee is generally bound by the prudent investor standard (British Columbia, Trustees Act “A trustee may invest property in any form of property or security in which a prudent investor might invest, …”). The value of NFTs is extremely volatile and would likely be considered too risky of an investment for a prudent investor. Accordingly, a trustee should be very hesitant to retain or invest in NFTs, without express permission from the testator of the will, the settlor in the trust instrument, a written release by all beneficiaries, or authorization in a valid court order.
If my client mints NFTs, are there any additional special warnings I should provide the client?
Yes, the client needs to be leery of creating NFTs that link to copyrighted work without permission of the copyright holder. Thus, a client should not mint an NFT that is linked to copyrighted property such as songs, videos, and artwork.
What are some future issues I may be asked to address about NFTs?
There are several potential issues regarding NFTs beyond those already mentioned that may cause concern in the future. One example is whether NFTs could be subject to federal securities laws.
If you have any questions or would like advice related to the matters set out in this post, or if you have questions in relation to matters of real estate, business law, intellectual property and trust and estate matters, please contact us at 604-688-4900 or by email to Paul Barbeau at paul@barbeau.co or to Morgan Best at morgan@barbeau.co