Staying Compliant: Navigating Tax Rates for Digital Assets, Cryptocurrency, and NFTs

Introduction

With the growing popularity of digital assets, it is essential to understand their tax implications. This includes understanding the digital asset and cryptocurrency tax rate.

Cryptocurrencies and other digital assets are subject to taxation with different rates depending on whether they are held short-term or long-term when considering capital gains taxes, as well as an individual’s income brackets when considering taxable income and short term capital gains. This article will provide a concise overview of these tax rates, providing an insight into how cryptocurrencies and digital assets are taxed in the United States.

It will also discuss the importance of tracking market values and cost basis appropirately and accurate accounting for digital asset owners so they pay their taxes appropriately when filing their taxes. The knowledge provided here can prove invaluable for anyone who wants to maximize their digital asset holdings while avoiding hefty tax penalties.

How are Crypto/Digital Assets Taxed?

Taxing digital assets is no different than taxing any other asset class. Digital assets, such as cryptocurrency and digital tokens, are generally taxed as property by the IRS. This means that when you purchase them and hold them for a period of time, you need to track your basis – what you paid for the asset – to calculate your gains or losses when you sell them accurately.

Depending on how long you held the asset and where it falls into capital gains brackets (short/long term) will determine the applicable tax rate.

Short-Term Capital Gains v. Long-Term v. Ordinary

It’s essential to understand the difference between short and long-term capital gains when it comes to digital asset taxation based on your holding period.

Short-term capital gains are taxes applied to profits generated from assets held for less than one year; these profits are taxed at the same rate as ordinary income (up to 37%).

Long-term capital gains apply to assets held for over one year and have lower tax rates than short-term gains. For example, individuals with an annual income of less than $40,000 may be eligible for a 0% tax rate on long-term capital gains.

Gains on cryptocurrencies generally aren’t applicable for ordinary income tax unless you were paid with digital assets for services, in which case they may be taxed as earned income.

Tax Rates depending on income brackets

When it comes to the taxation of digital assets, the amount paid in taxes depends on the individual’s income bracket. Higher earners will generally pay more tax on their digital asset gains than lower earners.

Net Investment Income Tax

Additionally, if your net investment income is over a certain level, it may be subject to an additional 3.8% Net Investment Income Tax (NIIT). It is critical that accurate accounting is done in order to avoid overpaying taxes owed on digital assets.

 What Tax Rate Applies To NFTs

The IRS has not officially provided guidance regarding the tax treatment of NFTs for capital gains tax or ordinary income purposes. 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.

Wrapping Up

Taxing digital assets is an essential consideration for anyone who holds them. You can maximize your investments by tracking your basis, understanding the applicable tax rates, and accurately accounting for your gains or losses from digital asset holdings while avoiding hefty penalties. It’s important to appropriately track your cost basis, fair market value and holding period of all digital asset purchase and sales.

Next Up

• Schedule a time to speak with our team in detail about your taxes and accounting.
• Read our Definitive Guide for Cryptocurrency Taxation to learn about cryptocurrency taxes from an experienced CPA.
• Read our Cryptocurrency Tax Planning Guide to learn about saving cryptocurrency taxes from an experienced CPA.
• Visit Digital Impost for NFT Sales Tax Compliance