NFT crypto market has developed into a multibillion-dollar industry, with top collections such as CryptoPunks and Bored Ape Yacht Club fetching tens of millions of dollars or more.
Needless to say, it’s been an eventful year for NFT investors, who should use the final weeks of 2021 to get ready for tax season in April.
“Right now in December, before the year ends, you want to know what your tax position is and how much capital gains you have,” says Kate Waltman, a crypto-focused certified public accountant in New York.
According to Waltman, the average client rarely inquired about the tax consequences of holding crypto and NFTs just a year ago.
“However, cryptocurrency has been a huge part of the discourse this year,” Waltman says. “And I would say that in the last four or five months, [clients] have started paying attention.”
The IRS, too, has focused on crypto activity: “The IRS is clearly putting a focus on crypto activity,” Waltman adds. “While they may not currently have the ideal infrastructure in place to track and evaluate many of these crypto transactions, I can tell you that it’s a priority.”
Even if your clients don’t anticipate selling any NFTs this year, you may help them prepare for tax season. Continue reading for five essential tax hints for NFT investors.
1. NFT purchases are taxable, whether or not you sell them.
According to Waltman, the IRS considers cryptocurrencies to be property rather than cash. So, like most NFT transactions, when you buy an NFT using bitcoin, you’re technically buying and retaining an asset for a brief amount of time.
According to Waltman, “for 98 percent of NFT purchases, you must spend some type of cryptocurrency,” such as ETH, SOL, or ADA. “When you acquire bitcoin and hold it for a short length of time, the value of that cryptocurrency will fluctuate, and when you use that cryptocurrency to buy an NFT, the value of that cryptocurrency will fluctuate as well.”
Read Also: What NFT means, And Why You Should Invest
As a result, the IRS considers NFT transactions to be a simultaneous sale of your cryptocurrency and the acquisition of a new asset that is also an NFT, resulting in a capital gain or loss. Fortunately, services such as CoinTracker make it easier to keep track of your NFTs and compute capital gains.
“However, if you buy an NFT using US dollars, which is available on some platforms,” Waltman argues, “it’s not a taxable event.”
2. Clients should know the difference between short- and long-term capital gains.
“When selling an NFT that you previously purchased, the most essential consideration is whether you fall into the short-term capital gains or long-term capital gains bucket,” Waltman adds.
Your client acquired and sold an NFT within a 12-month period, which falls under the short-term capital gains category. If clients have short-term capital gains, their tax rate is the same as their regular income tax rate.
If your client purchased an NFT and kept it for at least 12 months and one day before selling it, they fall into the long-term capital gains category. Depending on their overall income, the long-term capital gains rate is either 0%, 15%, or 20%.
“It’s 15 percent for most people,” Waltman adds, “and 15 percent is generally lower than what your ordinary income tax amount would be.” “Trying to fall into the long-term capital gains bucket and holding for 12 months and one day to decrease your tax payment is usually helpful from a tax standpoint.”
3. You can be taxed on airdrops and giveaways.
In the NFT realm, social media giveaways are prevalent. They usually take the form of an airdrop, in which an NFT creator or artist distributes tokens to their community or fan base.
“If you’re getting an airdrop as part of a giveaway or other prize, you’ll probably know what to expect since you’ll be told,” Waltman adds. Whether your client was a part of a recent launch, commented on a specific topic, or joined a Discord channel, they should be notified that an NFT is on its way.
While this is part of the fun of collecting NFTs, your clients should be aware of the tax implications.
“A lot of people have hoped that if you win a raffle or an airdrop, you won’t have to pay taxes.” “However, as we all know, the IRS is always looking for a piece of the action when it comes to awards and giveaways,” Waltman explains.
Prizes and giveaways will be taxed at your client’s regular tax rate (the USD equivalent value). Given the unpredictable and embryonic nature of NFTs, this may be subjective. However, an accountant can confirm the projected worth of the NFT asset using market data and blockchain records.
“A project like that with a well-established floor price will have a fairly readily available and easily determinable fair market value,” Waltman explains. “Similarly, the USD equivalent value of additional blue-chip, validated NFT projects would be rather easy to establish.” You may simply estimate the fair market value by going to OpenSea or another NFT trading platform and looking at the floor price and other comparable recent sales.”
When it comes to newer initiatives, the worth can be a little subjective, so your clients, as taxpayers, must just make a good faith effort.
“Work with your accountant and do your best to figure out what data is available from the market,” Waltman advises.
4. Gas fees can (and should) be counted in your capital gains.
“It’s critical to understand the tax treatment of gas fees,” Waltman explains.
When you buy an NFT, you’ll have to pay for gas. Unless the NFT developer has waived or lowered the gas fee, a buyer will almost certainly be charged a gas fee when purchasing an NFT. Gas fees, which may be as high as $200 (on Ethereum, in particular), are well-known for being high.
“Think of that expense you incur as a transaction charge,” Waltman explains. “In the NFT, you will add the gas fee amount to your cost basis. As a result, your cost basis is the NFT’s purchase price plus any petrol or other transaction expenses you’ve paid.”
The cost basis of an NFT is significant since the gain amount will be reduced if your client later decides to resell the NFT. For example, if they bought an NFT for $1,000 and sold it for $2,000, they would have made a $1,000 profit. When a $200 gas fee is added to a $1,000 purchase, the cost basis rises to $1,200. As a result, the profit is merely $800.
“This lowers the tax you’ll pay later when you resell,” argues Waltman.
5. Tax planning is still (if not more) important for NFT collectors.
Tax best practices are just as crucial – if not more critical – for NFT collectors.
“Know your tax situation before the end of the year,” Waltman recommends. “Right now, in December, before the year ends, you want to know what your tax situation is and how much capital gains you have, because you still have a few weeks to decide whether you need to conduct any tax loss harvesting, make charitable donations, or contribute to retirement.”
Tell your clients not to put off printing their paperwork from CoinTracker or another site until January 1st. Because they were not fully aware of the tax implications of NFTs, it will be too late for them to offset or prepare for big capital gains by then.
Waltman says, “That’s the circumstance we don’t want to see people in.”