Crypto and NFT Investors Face the Music on Tax Day

Ready or not, tax time is upon us once again. If 2022 is anything like last year, billions of dollars in refunds will be issued across 160 million-plus American filers who qualify. And while cryptocurrencies like bitcoin have been around for over a decade, they will undoubtedly be part of the conversation once again as wide-scale adoption has taken hold. Indeed, some 15% of the U.S. population owns cryptocurrency, according to Bloomberg.

This may not be crypto's first rodeo, but non-fungible tokens (NFTs), digital assets on the blockchain that have created millionaires out of thin air, are a newer phenomenon. NFTs might seem like simple jpegs, but users are plunking down six and seven-digit figures to have proof of NFT ownership on the blockchain, which it's safe to say has gotten the attention of Uncle Sam. Fortunately, the crypto tax apparatus has already been integrated into major providers, like Turbo Tax, for example, so the industry doesn't need to start over from scratch with NFTs.

Taxed as Property

Cryptocurrencies and NFTs are blockchain-based assets, but they have very different use cases. Bitcoin, for example, can be used as a payment method or store of value like gold, while NFTs are digital collectibles that might take the form of art, video, music, etc. Nevertheless, the IRS treats them similarly.

Both crypto and NFTs are taxed as property, the earnings from which are considered capital gains. If you own capital assets like real estate or stocks, you can expect similar treatment for your NFTs. Profits or losses realized in bitcoin or any cryptocurrency follow the same model as if you were to sell shares of Tesla, for example. The basis is the price you paid to acquire the asset, and the proceeds determine whether you've experienced capital gains or a loss. We thought now would be an excellent time to explore how Uncle Sam assesses all things crypto and NFT.

Fine Print

The cryptocurrency markets took investors on a roller coaster ride in 2021, with market leaders like bitcoin and Ethereum soaring to nearly $69,000 and $5,000, respectively, at their best levels before ending the year much lower ($46,306 for BTC and $3,682 for ETH). Despite the volatility, many cryptocurrency investors finished the year with capital gains, and they would no doubt like to hold onto as much of those profits as possible. The IRS, however, has every intention of keeping them honest, as evidenced by a question about virtual currencies positioned not only on the opening page of the 1040 document but also in the first section. There's no way to miss it, even if you wanted to.

1040
Source: IRS.gov

According to CPA Ryan Losi, EVP at PIASCIK, cited by CNBC, when it comes to cryptocurrencies and taxes, there are several critical taxable events. These include:

  • Trading or selling cryptocurrencies for a profit
  • Converting from one coin to another (BTC to ETH) or cashing out for Benjamins.
  • Paying for goods and services, like seeing “The Batman” and buying your tickets with Dogecoin. Crypto payments usually involve conversion to the mighty dollar and might be taxable, too. The IRS states, “Your gain or loss is the difference between the fair market value of the services you received, and your adjusted basis in the virtual currency exchanged.” The idea here is that multiple crypto payments can quickly grow into a hefty sum, even if it doesn't seem so at the time, so it's better to have a record of it than not.
  • Airdrops are events in which cryptocurrency projects “airdrop” a certain amount of their native crypto to users for free as a way to market their brand. It's free money as long as the crypto grows in value. If you've received crypto from airdrops, the IRS considers this regular income connected with your tax bracket.
  • If you receive crypto as a gift, and the value is less than $15,000, you won't have to report it as income. Any crypto gift above that amount and the gift-giver will need to file a gift tax return.

The IRS wants to know if you've experienced any gain or a loss, no matter how big or small. Your tax rate is based on the length of time you held the crypto. The longer you've held, the better for you.

For example, suppose you've got what the cryptocurrency community calls “diamond hands” and have managed to hold onto your crypto for over a year. In that case, your capital gains rate could fall in the range of zero to 20%, with your taxable income the wildcard factor. However, this is not always the case, as holding in crypto can be difficult amid market volatility. Therefore, it's not uncommon for cryptocurrency investors to find themselves facing a short-term capital gains tax, which is taxed as regular income at as much as 37% in the top bracket.

Whether you are an early cryptocurrency investor who reaped a million in profits or a newbie with a gain of $100, you need to keep the IRS in the loop. Otherwise, experts warn, it's likely to come back to haunt you.

NFTs: Property & Income

Suppose you are among the growing number of investors who earned a windfall from a CryptoPunks or Bored Ape NFT last year, or maybe one of these irresistible Invisible Friends, congratulations. However, now the time has come to pay the piper. According to crypto market data site CoinGecko, NFTs fall into the same bucket as cryptocurrencies even though the IRS hasn't addressed digital collectibles specifically. If you transacted in NFTs in 2021, either by minting, selling, buying, or trading, and you experienced a profit or a loss, it may have been a taxable event.

The way you'd be taxed for NFTs depends on certain factors, such as if you're minting or selling NFTs and whether you're doing so as a hobby or part of a side hustle. The price you pay for the cryptocurrency used for blockchain fees, known as gas, becomes taxable.

In a hypothetical example provided by CPA Shehan Chandrasekera to NextAdvisor, a hobbyist spends 0.1 ETH to mint an NFT. They paid $100 for the ETH, since which time the crypto has increased in value to $300. Therefore, they're sitting on capital gains of $200 and a taxable event. Whether it falls into the long- or short-term capital gains tax rate depends on when they bought the ETH and created the NFT. An NFT pro could treat the gas fee as ordinary income and write off the expense, Chandrasekera notes.

If you decide to sell or trade the NFT you minted, the IRS considers either scenario a taxable event. In this case, the transaction is taxed as income, assuming you're either earning more money or losing some. If that NFT continues to be sold in the secondary market, such as on an NFT marketplace, and you earn royalties, they too are taxed as income. NFTs are usually priced in cryptocurrencies; therefore, it's another taxable event if you buy one.

 

Use IRS Form 8949 to report your NFT as well as crypto profits and losses. Be sure and consult a tax professional for guidance. Tax day is April 18, 2022.

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This post was produced and syndicated by Wealth of Geeks.

Featured Image Credit: Shutterstock 

 


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