As a cryptocurrency lawyer, one often gets asked about the tax implications of buying, selling, and holding NFTs. NFTs, or non-fungible tokens, have exploded in popularity recently, with sales volumes exceeding $25 billion in 2021 alone. However, many collectors still need clarification about how NFT transactions are taxed. This blog post provides a comprehensive guide to understanding NFT taxation for cryptocurrency enthusiasts and investors.
What are NFTs?
For those new to the world of digital assets, NFT stands for non-fungible token. It is a special cryptographic token representing ownership of a unique digital asset like art, music, videos, or tweets. No two NFTs are identical, even if they are copies of the same underlying asset. This makes them very different from fungible cryptocurrencies like Bitcoin and Ethereum.
Every NFT has a unique identity and metadata encoded within it. This data includes information about the asset's owner, rich product descriptions, artifact properties, and specifics on how the artist created it. NFT ownership is recorded on a blockchain ledger, allowing easy verification of who owns what.
Why Tax NFTs?
NFTs are treated as capital assets by the US Internal Revenue Service (IRS), similar to stocks, bonds, real estate, and other investment properties. Hence, they are subject to capital gains taxes whenever they are sold at a profit. The tax rate can range from 0% to 37%, depending on how long you held the NFT.
Unfortunately, failure to report NFT profits or losses can attract scrutiny from the IRS. This happened in 2019 when the agency sent cryptocurrency owners letters requesting back taxes and penalties. You don't want an audit from the taxman!
When to Pay Taxes on NFTs
Generally, you owe taxes whenever an NFT is sold or traded for goods, services, or other cryptocurrencies.
Some key events that trigger capital gains taxes include:
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Selling an NFT for fiat currency like USD or stablecoins
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Trading an NFT for other cryptocurrencies like Bitcoin or Ethereum
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Using an NFT as payment for goods or services
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Gifting an NFT to someone else (if the value exceeds the annual exclusion amount)
However, merely buying or holding an NFT in your wallet does NOT incur taxes. Taxes are only owed when there is an actual sale event or transfer of ownership.
How NFT Taxes are Calculated
NFT taxes are calculated based on capital gains realized from the sale.
NFT Taxes Formula used:
Capital Gains = Selling Price - Cost Basis
Where:
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Selling Price is how much you sold the NFT for
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The cost basis is how much you paid to acquire the NFT originally
If you sell the NFT at a profit, the result is a capital gain. If you sell at a loss, then it is a capital loss that can be claimed as a tax deduction (up to $3,000 per year).
Example 1
John buys an NFT for 0.5 ETH ($1,000) in January 2022.
He sells the same NFT for 1 ETH ($2,000) in December 2022.
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Cost Basis = $1,000
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Selling Price = $2,000
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Capital Gains = Selling Price - Cost Basis
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= $2,000 - $1,000
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= $1,000
John realizes a $1,000 capital gain that must be reported on his tax return.
Example 2
Mary bought an NFT for $500 worth of DAI stablecoin in 2021.
She sold it for $200 worth of USDC stablecoin in 2022 at a loss.
Cost Basis = $500
Selling Price = $200
Capital Loss = Cost Basis - Selling Price
= $500 - $200
= $300
Mary can claim a $300 capital loss deduction on her taxes.
Short-term vs Long-term Capital Gains
The IRS taxes short-term gains at higher ordinary income tax rates while long-term gains get preferential rates.
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Short-term capital gains- These apply to assets held for 12 months or less before being sold. Your regular income bracket determines the rate.
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Long-term capital gains- These require you to hold assets longer than a year before selling. Preferential rates of 0%, 15% or 20% apply based on taxable income and filing status.
The difference can be very significant - up to 20% points sometimes!
As an intelligent NFT investor, holding your collectibles over 12 months benefits you from lower long-term capital gains tax.
Cost Basis & Holding Periods
Tracking the cost basis and holding period is crucial for accurately calculating NFT taxes.
The cost basis refers to your original purchase price plus additional costs for acquiring the NFT. This includes:
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The amount you paid for the actual NFT
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Gas fees for minting or transferring tokens on the blockchain
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Platform fees paid to NFT marketplaces
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Transaction fees for crypto exchanges
Meanwhile, the holding period determines whether gains qualify as short-term or preferential long-term rates. It is measured from the acquisition date to the sale date.
Ensure detailed records of when and how much each NFT was acquired are maintained. Also, document any fees paid during the process. This will help calculate taxes correctly and substantiate your tax position during an audit.
Tax Forms to Report NFT Income
So, how exactly should you report NFT taxes?
The primary tax forms include:
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Schedule D Form 1040- Used to report overall capital gains and losses from investment assets. It must be attached to your standard 1040 tax return.
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Form 8949- Provides a detailed summary of capital gains and losses. Supports the high-level numbers reported on Schedule D.
You don't need to file Form 8949 if aggregate capital gains/losses amount to less than $5,000. Schedule D is still required if you meet the filing threshold.
These forms help reconcile taxes owed based on short-term and long-term holding periods.
Ensure to report all crypto and NFT transactions for the tax year, even if there were losses. This ensures you claim eligible deductions and provides an audit trail later if needed.
Taxes on NFT Airdrops & Giveaways
Many NFT projects distribute free tokens to early supporters via airdrops, bounties, or giveaways. Receiving free NFTs is tax-free income. However, you may still need to pay taxes in some instances!
The general rule is that airdropped NFTs are taxed once sold. The capital gain realized is taxable based on the sale price less the cost basis.
Since airdropped NFTs were acquired for free, the cost basis is zero. Hence, the entire sale value is treated as capital gains for tax.
Gifted NFTs are also subject to similar taxation once sold. One exception is receiving gifts from family members who may qualify for special exemptions. However, the full sales value for non-family gifts is taxable income for recipients.
This highlights the need to track airdropped and gifted NFTs closely. Make sure to document zero cost entries and date of acquisition accurately.
Dealing with Stolen or Lost NFTs
Stolen or lost NFTs also carry tax implications that collectors must consider.
If an NFT is stolen or forcibly transferred from your wallet, it counts as being disposed of. Unless you recover the actual NFT tokens, you may need to report this as a disposition on taxes.
Value the NFT using fair market estimates at the time it was stolen. Then, claim a casualty loss deduction on Schedule A while filing Form 4684. Ensure to report the theft to the IRS and maintain evidence for records.
Lost NFTs, like sending tokens to the wrong address, carry similar tax treatments. Do your best to determine fair market value when the asset is lost completely. The amount can then be claimed as a capital or ordinary loss on taxes subject to limits.
Maintaining meticulous records is vital to substantiating these deductions later during audits or IRS inquiries.
Using Third-Party Tax Tools
Given the complexities of NFT tax reporting, many collectors utilize specialized crypto tax software to make the process easier.
Platforms like TokenTax, Koinly, and CoinTracker help you:
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Automatically import NFT transactions from wallets and exchanges
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Accurately calculate capital gains and losses across chains
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Maintain documented audit trails with diagnosis reports
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Generate completed tax forms like IRS Form 8949
This eliminates the manual work needed to track, evaluate, and reconcile thousands of transactions associated with NFTs. Everything is handled automatically using customizable reports that integrate directly with TurboTax or other tax prep software too.
Using tax calculators is highly recommended for active traders dealing with daily NFT buys/sells across multiple wallets and platforms. This saves time and provides peace of mind that your crypto taxes are being done right.
Tax Tips for NFT Owners
Here are some additional tips to help NFT collectors maximize returns while remaining compliant:
Classify Nfts Under Long-Term Holdings
Holding NFTs over 12 months qualifies for lower preferential tax rates. Plan suitably to minimize taxes paid.
Track Yield From Nft Staking & Lending
Yield-bearing NFTs provide regular income, which must be reported as ordinary taxable income annually.
Maintain Detailed Transaction Records
Document NFT purchase dates, costs, sale prices, fees paid, etc. Accurately. This data is crucial for taxes.
Evaluate Tax Implications Before Gifting
Gifted NFTs still carry tax obligations for recipients unless exempted under special rules.
Report Losses For Stolen/Lost Nfts
Being hacked or losing NFTs entitles you to claim tax deductions for these events.
Proactively considering taxes early allows NFT collectors to optimize decisions focused on wealth creation rather than simply asset accumulation alone.
Frequently Asked Questions About Taxes and NFTs
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Is Merely Buying An NFT a Taxable Event?
NO, BUYING OR BEING GIFTED AN NFT DOES NOT DIRECTLY TRIGGER TAXES. TAXES ARE ONLY OWED WHEN THE NFT IS LATER SOLD AT A PROFIT OR USED AS PAYMENT FOR GOODS/SERVICES.
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If I Sell An NFT At A Loss, Can I Save On Taxes?
YES, SELLING AN NFT FOR LESS THAN YOUR PURCHASE PRICE RESULTS IN A CAPITAL LOSS. THIS CAPITAL LOSS CAN BE CLAIMED AS A TAX DEDUCTION, UP TO $3,000 PER YEAR TO OFFSET REGULAR INCOME.
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What If I Trade One NFT For Another - Is This Taxable?
TRADING ONE NFT FOR ANOTHER NFT (OR OTHER CRYPTO ASSETS) COUNTS AS A SALE EVENT. ANY CAPITAL GAINS OR LOSSES MUST BE CALCULATED AND REPORTED APPROPRIATELY ON TAXES.
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Do I Have To Pay Sales Tax When Selling An NFT?
NO, NFTS ARE CONSIDERED DIGITAL ASSETS, SO THEY ARE NOT SUBJECT TO ANY ORDINARY SALES TAX AS PER CURRENT LAWS. HOWEVER, INCOME FROM NFT SALES IS CATEGORIZED AS CAPITAL GAINS WITH DIFFERENT TAX RATES.
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Can I Deduct NFT Gas Fees And Transaction Costs?
YES, GAS FEES PAID FOR MINTING, TRANSFERRING NFTS, AND RELATED PLATFORM FEES ARE ALL DEDUCTIBLE COSTS CONTRIBUTING TO ADJUSTING THE COST BASIS. THIS ULTIMATELY IMPACTS TAX CALCULATIONS.
Work with an NFT Lawyer at Bull Blockchain Law
With NFT trading volumes and ownership rising, it pays to learn the basics of NFT tax rules to avoid misreporting income or footing unnecessary tax bills. Whenever you sell or dispose of NFTs for profit, capital gains taxes apply based on the length of the holding period.
Make sure to maintain detailed documentation of purchase dates, costs paid, sale receipts, and other transaction metadata to reconcile taxes accurately. Leverage reliable crypto tax software to eliminate manual effort since the number of taxable events across multiple NFTs and chains increases over time.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.