How to Tackle Tax Surprises on Cryptocurrency and NFT Investments
By: Christopher Rogers, Senior Tax Partner, Capital Fund Law Group
NFT’s (Non-fungible tokens) are in vogue, and they are what’s trending in the crypto economy. While it is a fairly new phenomenon, they continue to increase in popularity. With that, a new crop of investors have entered a world that has, for the most part, been viewed as untouchable and esoteric. People are now putting their money into these NFT’s, and they are changing the values of luxury items such as artwork and collectibles, along with bespoke content that includes videos, music, GIFs and more. In addition, it has been an education for individuals who are invested in crypto, as they seek innovative ways to increase their net worth. Those who are investing in NFTs and cryptocurrency trades, however, may not be aware of the tax rules and implications that govern this new class of transactions.
Tax implications of investing in Bitcoin and other cryptocurrencies
Bitcoin, or any other cryptocurrencies, are subject to an array of tax implications. Depending upon the type of transaction that’s being made will determine if it is considered a taxable event.
Investors that exchange one coin for capital gain is a taxable event. The IRS views cryptocurrency as property, not currency (although note, the IRS has provided particular guidance on the taxation of cryptocurrency if used to pay wages, which is outside this article).. Regardless of how it is being used, investors will owe taxes if the value of the cryptocurrency is higher than what you purchased.
Every exchange of one coin to another is a taxable event, and any differences between the taxpayer's basis in that coin and the price of the new coin is taxable, generally as capital gains. For example, if the investor purchased $20,000 worth of ETH in January 2020 and exchanged that $20,000 of ETH for $30,000 of BTC in September of 2020, the investor would have taxable capital gains of $10,000.
Using cryptocurrency to buy goods and services is also considered a taxable event. Even if you are buying a cup of coffee at a store that accepts crypto, it is similar to just selling crypto trading, stocks, or bonds. The IRS website states that “the use of virtual currencies to pay for goods or services . . . generally has tax consequences that could result in tax liability.”
The buy-and-hold period of a coin is a taxable event which can affect your tax rates. Your income and the amount of time the cryptocurrency is held are the two factors that crypto-asset gains are calculated in the United States. Crypto asset gains can be both short term and long term that will then determine the crypto tax rate.
As discussed above, the ETH was held for less than a year, which means the capital gains will be short-term which are taxed at ordinary rates that max out currently at 37%. However, if the ETH had been purchased in August 2019, then the capital gains would be long-term capital gains rates which max out at 20%. Note, as of the writing of the article, there has been executive orders and/or legislation proposed that would increase or modify the calculation of both the ordinary income tax rates and long-term capital gains rate
Taxable Events Related to NFT’s
The most common activities related to NFT’s, that are taxable events include:
- Purchasing NFT’s;
- Exchanging an NFT with another NFT;
- Selling an NFT for cryptocurrency.
Investors generating profits on NFT’s through operational activities such as rents, loyalties, fees, etc. is another taxable event. Income that is earned from NFT’s are subject to capital gains tax rates up to 37%. Since NFT’s are not converted into cash, investors may suffer taxable consequences even without generating income from NFT’s.
How are cryptocurrencies and NFTs taxed, and when?
As of today, it has not been officially expressed by the IRS on how taxes should be treated for NFT’s. Most likely, NFT’s are probably going to have the same tax treatments as cryptocurrencies. The tax rate for an NFT will solely determine how long investors hold on to their assets for short term or long-term capital gains. Short-term capital gain tax rates only apply for NFT’s that are held for less than a year.
NFT’s are also subject to being taxed based on whether it is a regular capital gain or a collectible capital gain. As clearly defined by the IRS, collectible NFT’s are any work of art, antique, stamp, or any other tangible property. Therefore, any NFT collectible held for more than one year by an investor can result in high collectible tax rates. Overall, the more NFT transactions will equate to complicated tax rates.
For cryptocurrencies, they are taxed like stocks and bonds - which are treated as capital assets in the eyes of the IRS. When it comes to tax on cryptocurrency, investors only owe taxes if you spend or sell cryptocurrencies and have earned a profit from it. On the other hand, if you didn’t make a profit from selling or spending your cryptocurrency, investors won’t owe anything during tax season.
Unanticipated tax bill - Now What?
If you receive a tax bill on crypto and NFT investments, there are a few things you can do. Above all else, there is one thing that is non-negotiable: ignoring the bill. Be sure to face the taxes owed and devise a plan. See below for a few viable options:
Option 1: Sell coins to pay off tax bill
If you are an investor who has cryptocurrencies/NFT’s to sell, this might be the obvious answer. However, what if you don’t have any virtual currencies to sell? If that is the case, the IRS generally allows investors to pay back taxes over a span of six months. To do this, you would need to fill out documentation that is provided by your local tax office.
Option 2: Enroll in a payment plan with the IRS
This option only applies if the tax liability is less than $50,000. The investor and the IRS will come to an agreement on the amount to be paid monthly. To add, the IRS is authorized to approve or deny the payment plan. If the IRS approves, then that means the investor has six years to make all future payments. However, it is not recommended to solely rely on this option as it is not guaranteed.
Option 3: Offer in Compromise
Defined by the IRS, an offer in compromise allows you to settle your tax debt for less than the full amount you owe. To get qualified for an offer in compromise must be based on the various factors:
- Financial condition of the taxpayer
- Debt amount
- The offer
- Occurrence of the debt
An Offer in Compromise is the most difficult to obtain of the options available. You cannot simply call the IRS and ask for a deal. This option consists of filling out IRS forms, providing financial information, and coming up with an offer amount.
Option 4: Consult with a Tax Professional and/or Attorney who specializes in taxation
Overall, investors should meet with a tax consultant (CPA or Attorney) so that a professional can provide the best advice for your individual tax situation. Keep in mind that there are solutions.
Christopher Rogers, Esq. is a senior tax partner at Capital Fund Law Group, where he advises clients in the areas of investment fund formation, securities law, corporate law, and taxation. Mr. Rogers also provides guidance on the structuring, establishment, and compliance of hedge funds, private equity funds, real estate funds, and other alternative investment vehicles, such as digital assets. For more information about Mr. Rogers and Capital Fund Law Group, please visit their website at: https://www.capitalfundlaw.com/
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.