What you Need to Know about NFTs and Taxes

Bitcoin emerged back in 2008 as a digital asset that wielded cryptography to secure peer-to-peer electronic transactions. Since those early days, the blockchain has (literally) gathered energy, and now fuels a creator economy born of the affordances of the NFT. 

Yet it wasn’t until 2017, when Bitcoin (BTC) and other cryptocurrencies experienced their first bull and bear markets, that the cryptosphere achieved recognition as a viable site for wealth creation. The NFT explosion of 2021 further reinforced this trend, whilst also training the sights of tax authorities on a new class of art collector. Whether we like it or not, these new opportunities for wealth creation (and art enjoyment!) require us to report and pay taxes. Not even a crypt can hide us from that responsibility.

Here are the key things you need to know about cryptocurrency, NFTs, and taxes.

1. You need to report all of your transactions and all of your wallets. “Nobody’s gonna know” is a common, but mistaken, refrain in the cryptosphere. The Internal Revenue Service is investing a lot of time, money, and effort in getting the correct tools in place to audit tax returns. If you have ever interacted with any of your KYC wallets, the IRS will be able to find out and get those taxes, even many years later. It has the benefit of hindsight and audits usually happen a few years after the fact.

2. The IRS views everything in USD not crypto. When you buy and sell crypto, the IRS looks at the USD value at the exact moment that the transaction happened so don’t look at things as 1 ETH = 1 ETH but actually the USD value at the time of transaction. Take the following example: You purchase an NFT for 2 ETH when ETH was $500 per ETH for a total cost basis of $1,000. You then sell it for 1 ETH when ETH was $2,500 per ETH. Looking at it in pure ETH terms, you lost an ETH but the IRS will look at it as if you sold an asset for $2,500 with a cost basis of $1,000 resulting in a taxable gain of $1,500.

3. All transactions are considered taxable. As the rules are currently written there is no way to do a 1031 exchange to defer taxes. The only transaction that doesn’t cause a taxable event is moving from USD to crypto. Moving from crypto to USD is a taxable event as is any crypto-to-crypto or crypto-to-NFT transaction.

4. Your taxes due depend on what you do. Artists and investors get taxed very differently. If you are creating art in the form of an NFT then you’ll get taxed as ordinary income tax, whilst an investor who sells work for more than they paid will incur capital gains tax. To take another example: If you are part of the team behind a PFP project or an artist that sells single edition works of art, all of the revenue from the primary sale and also secondary income will be considered taxable as ordinary income at the current top marginal tax rate of up to 37%. If you buy a work of art from an artist or project you like then it is considered an investment and as a result you will be able to receive capital gains treatment on your investment. Whether a short or long-term tax rate applies will depend on whether you held it for more or less than a year and a day.

5. Record keeping is the responsibility of the taxpayer. It doesn’t matter if the exchange fails to provide you with a 1099-B form or the exchange or coin disappears and you are no longer able to access the relevant statements. It is the responsibility of the taxpayer to maintain all records of transactions, gains, and losses. We recommend using data aggregation software like Crypto Tax Calculator to do this. However, please note that no software will provide you with an exact answer, nor will it capture everything you need. Make sure to review the outputs that it provides prior to putting them on your tax return. If the result is too good to be true, it is your responsibility as the taxpayer to make sure it is correct.

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6. Estimated taxes need to be paid. It doesn’t matter if you are an artist or an investor, the IRS and states want to have the money in their hands during the year. As a result, you are required to make estimated payments on a pay-as-you-go system during the year. If you don’t make estimated tax payments during the year you may be charged penalties and interest. This is very important if you aren’t also a W2 employee during the year whereby taxes are withheld from each paycheck you earn. There are ways to reduce or limit the penalties and interest so make sure you review your crypto activity throughout the year, know your gains and losses, and make the estimated tax payments as appropriate. Generally speaking, estimated taxes are due April 15th, June 15th, September 15th, and January 15th of the following year, so for Tax Year 2022 they will be due April 18, 2022, June 15, 2022, September 15, 2022, and January 17, 2023. 

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7. Filing your tax return. At the end of the day, it is the responsibility of the taxpayer to file a complete and accurate tax return which they sign under penalty of perjury. If there is an audit or notices are sent demanding additional taxes plus penalties and interest, it is ultimately the responsibility of the taxpayer. Even if you can’t pay the tax due, make sure you file your tax return to avoid penalties for not filing a tax return.

8. Extensions and how they work. If you find yourself in a situation where you don’t have enough time or information to completely and accurately review and file a tax return, you can file an extension with the IRS and state. The biggest thing to remember is that an extension is an extension to file not an extension to pay, so make sure to arrange payment to the IRS and state to reduce or eliminate the amount of interest due.‍

In sum, be sure to keep as thorough records as possible and to file tax returns as completely and accurately as you can because there was a lot of wealth and income generated in 2021. If crypto and NFT prices follow their current course, 2022 will be the same story. With all of the budgetary pressures that have followed the pandemic, we expect to see a large number of audits in 2023 and 2024 from both the IRS and states.