NFTs Are The Next Big Thing In Crypto And The Taxman Is Aware

The following is a contributed article from a content partner of Benzinga

NFTs (Non-Fungible Tokens) are now the next big thing in crypto — of course, DeFi is still the overarching theme, but NFTs present a live and practical application of how decentralized technologies will upend the traditional financial industry. NFTs are simply a kind of digital token used to represent a digital or physical asset (anything of real or perceived value) to facilitate the trade, exchange, or transfer of such value in the digital world.

One of the most popular NFT sales was Jack Dorsey’s first-ever tweet, which sold was $2.9 million. The more jaw-dropping NFT sale was Beeple’s "Everydays - The First 5000 Days" art which sold for $69 million to set the stage for NFTs becoming the future of art and collectibles. Beyond the sale and purchase of NFTs by celebrities, regular people are starting to pile into the NFT business and in Q1 2021 alone, more than 25,000 NFTs have been sold with a combined value of more than $33 million.

If you missed the early days of Bitcoin, the 2017 ICO rush, and the initial DeFi momentum, NFTs may look like an attractive opportunity to ride the newest wave of innovation. However, before you start collecting and trading NFTs, you should remember nothing can be said to be certain, except for death and taxes. Hence, this piece provides a laydown on NFT taxes and how to ensure that you don’t unintentionally break tax laws. 

Tax Authorities Can And Will Tax Capital Gain On NFT Transaction

In 2014, the IRS issued Notice 2014-21, which effectively classified cryptocurrencies as property on which taxes could be applied. The IRS also went as far as showing examples of different tax principles applicable to property transactions and it showed how such tax principles are relevant to crypto transactions. 

Many other jurisdictions also have similar or are about to release policies that subject cryptocurrencies to income, capital gain, and other types of taxes. For instance, in the U.K. the HRMC has released guidance to say that individuals will be required to report capital loss or gains and to pay Capital Gains Tax when they dispose of their cryptocurrencies. 

NFTs are a new breed of cryptocurrencies, but they still fall within the general class of crypto products and services. Hence, the IRS, and reasonably, tax authorities in other countries, will logically expect you to file taxes when you buy an NFT using a fungible cryptocurrency such as Bitcoin when you sell an NFT for another NFT, or when you sell an NFT for a fungible crypto asset.

To be clear, the IRS and tax authorities in other countries won’t tax you merely for holding NFTs. However, the IRS has a “sale and other disposition of assets” rule that submits that “if you exchange virtual currency held as a capital asset for other property, including for goods or for another virtual currency, you will recognize a capital gain or loss.”

Ignorance Is Not An Excuse For Not Paying Taxes On NFTs

In 2019, the IRS started going after cryptocurrency investors for unpaid taxes, the agency reportedly sent out 10,000 letters to Americans who may have not paid taxes on their cryptocurrency transactions. The letters, labeled, Letter 6173, Letter 6174, and Letter 6174-A varied slightly depending on the individual circumstances of the recipients, and they more like “gentle” reminders about crypto tax obligations and what needs to be done to correct oversights. However, it is well understood that less “gentle” letters will follow if the tax bills remain unpaid. 

The letters were sent out months after the IRS got a court order to compel Coinbase to provide it with information about Americans who have bought at least $20,000 worth of cryptocurrencies between 2013 and 2015. However, already in 2021, the IRS has started collating a new list of people who may have defaulted on paying crypto taxes. 

On March 30, 2021, the IRS issued a John Doe summons to Kraken, and Circle (the promoter of Poloniex) got its John Doe summons on April 1, 2021. The summons required both exchanges to release information about user accounts that traded at least $20,000 worth of crypto assets between 2016 and 2020. According to IRS Commissioner Chuck Rettig, the reason for issuing the summons is to “enable the IRS to uncover those who are failing to properly report their virtual currency transactions. We will enforce the law where we find systemic non-compliance or fraud.”

As you would have guessed, there’s a hefty price to pay for non-compliance. For instance, there is a failure-to-pay penalty which starts at 0.5% of the unpaid tax amount per month but capped at 25%, which is still a very high figure that could eat into your margins. 

Secondly, there is a 5% penalty for late filing, which accrues per month starting from when the tax payment is due. The IRS encourages people to “file even if you can’t pay” to avoid the late filing penalty.  

Computing And Filing Taxes On NFTs Are Easier Than You Think

Failing to pay taxes on your NFT and general crypto transactions could potentially land you in trouble with the law. The IRS and other tax authorities frown at underreporting or not reporting taxes. Crypto tax software solutions such as CryptoTaxCalculator can help you sort through the complexities of your NFTs transactions to compute your capital gains or losses so that you can file accurate tax returns. CryptoTaxCalculator was ideated in 2018, soon after the ICO frenzy, when the founder Shane Brunette couldn’t find a simple tool for calculating crypto taxes. Shane, a software engineer who holds Masters in Artificial Intelligence, as well as a double degree in Psychology and Economics, was able to leverage his education and expertise to build a simple tool that can accommodate the vast complexity underpinning cryptocurrency tax calculations at a global level while hiding this complexity behind a simple and intuitive interface.

If you are an active day trader, you’ll probably place 100s of trades within a single portfolio on any given day and it might be somewhat difficult to track applicable taxes. But there could be more complex layers of transactions, for instance, if you take a crypto loan against some crypto assets and then use that loan to purchase an NFT, only to exchange the NFT for another NFT after some time; you’ll have a complex transaction chain for which a manual tax calculator might be tedious.

Final Words

By using crypto tax software, all you’ll need to do is connect your exchange data or public wallet address via API keys, and the platform will then import and categorize your transaction history and then help you compute reports to know your payable taxes.
Ignorance is not an excuse under the law and the fact that you may not be aware of applicable taxes on NFTs or crypto transactions won’t exonerate you when you run afoul of tax laws. The U.S. is leading the setting the pace for ensuring that all taxes on crypto transactions are paid and you can expect other tax jurisdictions to step up going forward. The best you can do is to accept the certainty of taxes and take proactive measures to put your books in order. 

Photo by fabio on Unsplash