NFTs have exploded in popularity among investors, artists, gamers and enthusiasts. It’s important to understand the tax consequences to NFT transactions to ensure you do not overpay in taxes or overlook tax filing obligations. In most circumstances, there will be tax implications to any transaction you make realted to NFTs.
We’ll go over how taxes are applied to NFT transactions, accounting for NFT transactions and overall best practices when it comes to NFT taxes and accounting. This will help you not only avoid interest in penalties with the IRS but also help to avoid overpaying due to volatility and other risks associated with cryptocurrency.
How Are NFT’s Taxed For Investors
The IRS has not officially provided guidance regarding the tax treatment of NFTs. Based on existing guidance realted to virtual currencies, NFTs are most likely property.
In most cases, NFT’s that are bought and sold as an investment will be liable for capital gains. If you earn rewards from holding the NFT this will be treated as income.
It is still unclear if NFT will be taxed at a capital gains rate or be classified as a collectible and taxed at a 28% rate. Since the IRS has not issued guidance on NFT taxation, investors and tax professionals are left speculate about how these assets should be treated. Because NFTs have similarities with fine art and trading cards, some have speculated that they would be considered collectibles, and thus receive the higher 28% collectibles capital gains tax rate. However, others argue that because buyers often purchase NFTs primarily as investment vehicles, the asset class would likely be treated as regular capital assets, and thus receive the normal capital gains tax rate. This position reflects the fact that although a NFT may contain a PFP or an art file, many also come with financial benefits such as voting rights, accruing cash flows, or staking. Overall, each NFT should be considered uniquely.
Our current position is that instead of being considered collectibles, NFTs are more clearly classified as “digital assets,” which the IRS has deemed subject to regular short-term and long-term capital gains rates. This opinion is bolstered by the fact that NFTS are “intangible” digital files and the tax code currently only gives the IRS the right to reclassify “tangible” objects as collectible items.
Crypto to NFT
When you use a cryptocurrency to purchase an NFT this will trigger a taxable event because you are selling the cryptocurrency in order to purchase the NFT. This means that you will be taxed on the current value of the cryptocurrency less the original cost basis for this asset. This is important to keep in mind during a bull market or if you have a low basis in a crypto asset. If you use these assets to purchase NFTs you may trigger capital gains on the sale of the cryptocurrency and have to pay the tax out of pocket since the cryptocurrency was used to purchase an NFT.
NFT to Crypto or USD
When you use a USD to purchase an NFT this will not trigger a taxable event. The purchase of the NFT will establish your cost basis in this asset which will be included in your gain/loss calculation when you sell the NFT.
NFT for NFT
Trading an NFT for another NFT will be a taxable event. This will be treated as a sale of the original NFT which can trigger a taxable gain or loss depending on the value of the NFT that you receive.
Minting an NFT is not a taxable event if you mint using USD or a stablecoin. If you mint using a cryptocurrency, such as ETH, you will trigger a gain or loss when disposing of the ETH to purchase an NFT.
You can donate NFTs to charities that accept them. As long as you donate the NFTs directly to the charity you will not be taxed when donating the NFT. You must donate directly to the charity, as selling it first would be taxable
Additionally, depending on how long your held the NFT you are eligible for a charitable deduction as an itemized tax deduction.
if you held your NFT for one year or less then you can deduct the lesser of your basis in the NFT or its fair market value up to 50% of your annual gross income. If the asset was held as an investment for more than one year and you itemize deductions, you may deduct the fair market value which is determined by a qualified appraisal of the gift, up to 30% of your adjusted gross income.
To substantiate your charitable income tax deduction, you are required to complete Form 8283 and obtain a qualified appraisal from a qualified appraiser for contributions of NFTs valued at more than $5,000.
Once you’ve identified a charity, you’ll need to make sure it is a qualified charitable organization under the IRS. Qualified organizations must meet specific requirements as well as IRS criteria and are often referred to as 501(c)(3) organizations.
Donor-advised funds, which are 501(c)(3) public charities, can be a tax-efficient solution for accepting contributions of cryptocurrency, as the funds typically have the resources and expertise for evaluating, receiving, processing, and liquidating non-cash assets.
The IRS has not provided formal guidance related to NFTs and accounting method selection. Since NFTs will most likely be taxed as property this would make it subject to the existing rules related to capital gains on unique or specifically identifiable property.
NFTs are unique and each token cannot be duplicated unlike fungible tokens like BTC or ETH where each asset is interchangeable and worth the same amount at any given moment. Since each NFT is unique under existing rules related to property accounting you will be required to track the purchase price of each NFT and use that purchase price as the cost basis when calculating get gain or loss when you sell that particular NFT.
Accounting methods outlined in the IRS Virtual Currency FAQs that detail requirements related to FIFO and specific identification accounting do not currently apply to NFTs.
How Are NFT’s Taxed For Artists and Companies
If you are an individual, artist or company that is selling NFTs as part of a trade or business activity you need to consider how sales taxes are applied to the sale of each NFT you sell. Do not avoid this and overlook a huge tax bill. It’s important to consider the tax consequences immediately to avoid overpaying in taxes. If you do not properly assess, collect, report and remit the sales taxes that you may be liable for selling NFTs you are creating audit and penalty risk for your company.
Learn more about how sales taxes apply to NFTs here.
Most people believe that when they get their taxes completed, their CPA has helped them organize their life to pay as little taxes as possible. But that’s not true. There is a huge difference between tax preparation and tax planning.
When you get your tax return prepared, your CPA is focused on accurately and timely fling your tax return based on your historical information. Tax planning is a process designed to protect your assets and minimize your taxes for future and current tax years.
The key to minimizing taxes is planning in advance. If you wait until you file your tax return to consider your taxes, it is likely too late to utilize many powerful tax planning opportunities available to you. That’s why we tax plan.
Learn more about how sales taxes apply to NFTs here.
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