• September 27, 2023

How to Tackle Tax Surprises on Cryptocurrency and NFT Investments

By: Christopher Rogers, Senior Tax Partner, Capital Fund Law Group

NFTs (non-fungible tokens) are trending and are the trend in the crypto economy. Although it is a relatively new phenomenon, they are becoming increasingly popular. With that, a new generation of investors has entered a world that has largely been viewed as sacrosanct and esoteric. People are now putting their money into these NFTs, and they are changing the values ​​of luxury items like works of art and collectibles, along with bespoke content like videos, music, GIFs, and more. Additionally, it has been a training course for people invested in crypto as they look for innovative ways to grow their net worth. However, those who invest in NFTs and cryptocurrency businesses may not be aware of the tax rules and implications that govern this new type of transaction.

Tax implications of investing in Bitcoin and other cryptocurrencies

Bitcoin or other cryptocurrencies are subject to a number of tax implications. Depending on the type of transaction made, it is determined whether it is a taxable event.

Investors exchanging a coin for capital gain are a taxable event. The IRS considers cryptocurrency to be property, not currency (although the IRS has provided specific guidance on cryptocurrency taxation when paying wages outside of this article). Regardless of how they are used, investors owe taxes if the value of the cryptocurrency is higher than what you bought.

Any exchange of one coin for another is a taxable event, and any differences between the taxpayer’s base in that coin and the price of the new coin are taxable, generally as capital gains. For example, if the investor bought $ 20,000 worth of ETH in January 2020 and exchanged that $ 20,000 ETH for $ 30,000 BTC in September 2020, the investor would have taxable capital gains of $ 10,000.

Using cryptocurrency to purchase goods and services is also considered a taxable event. Even buying a cup of coffee from a store that accepts crypto is similar to selling crypto trades, stocks, or bonds. The IRS website conditions that “the use of virtual currency to pay for goods or services. . . usually has tax consequences that can lead to tax liability. ”

The buy and hold period of a coin is a chargeable event that can affect your tax rates. Your income and the time the cryptocurrency is held are the two factors that are used to calculate profits from crypto assets in the United States. Profits from crypto assets can be both short and long term, which then determine the crypto tax rate.

As noted above, ETH has been held for less than a year, which means the capital gains are short-term and taxed at ordinary rates, which currently stand at a maximum of 37%. However, if ETH had been bought in August 2019, the capital gains would be long-term capital gains rates that a maximum of 20%. Note that at the time this article was written, implementing regulations and / or laws were proposed that would increase or change the calculation of both the ordinary income tax rate and the long-term capital gains rate

Taxable Events Related to NFTs

Some of the most common activities related to NFTs that are taxable include:

  • Purchase of NFTs;
  • Exchange one NFT with another NFT;
  • Selling an NFT for cryptocurrency.

Investors making profit on NFTs through operational activities such as rents, loyalties, fees, etc. are another chargeable event. NFT income is subject to a capital gains tax rate of up to 37%. Since NFTs are not converted into cash, investors can face tax consequences even if they do not earn any income from NFTs.

How are cryptocurrencies and NFTs taxed and when?

To date, the IRS has not made an official statement on how taxes should be treated for NFTs. Most likely, NFTs will have the same tax treatments as cryptocurrencies. The tax rate on an NFT only determines how long investors hold their assets for short-term or long-term capital gains. Short-term capital gains tax rates only apply to NFTs held for less than a year.

NFTs are also subject to taxation based on whether it is a regular capital gain or a recoverable capital gain. As clearly defined by the IRS, collectable NFTs are any work of art, antiques, postage stamps, or other tangible item. Therefore, any NFT collectible that an investor holds for more than a year can result in high withholding tax rates. Overall, more NFT transactions result in 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 taxes on cryptocurrencies, investors only owe taxes when they issue or sell cryptocurrencies and have made a profit on it. On the other hand, if you haven’t made a profit from the sale or issuance of your cryptocurrency, investors don’t owe anything during tax season.

Unexpected tax bill – what now?

When you get a tax bill for crypto and NFT investments, there are a few things you can do. One thing in particular is non-negotiable: ignoring the bill. Make sure you face the taxes owed and work out a plan. Here are a few viable options:

Option 1: Sell coins to pay the tax bill

If you are an investor who has cryptocurrencies / NFTs to sell, this could be the obvious answer. But what if you don’t have any virtual currencies for sale? If so, the IRS typically allows investors to repay taxes over a six month period. To do this, you need to fill out documents that will be made available to you by your local tax office.

Option 2: Sign up for 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 agree on the monthly amount to be paid. In addition, the IRS has the power to approve or reject the payment schedule. If the IRS agrees, it means the investor has six years to make all future payments. However, it is not recommended to rely solely on this option as it is not guaranteed.

Option 3: Offer in compromise

Defined by the IRS, an offer in compromise allows you to pay off your tax liability for less than the full amount you owe. In order to qualify for a compromise offer, several factors must be considered:

  • Financial position of the taxpayer
  • Debt amount
  • The offer
  • Origin of guilt

A compromise offer is the most difficult of the available options to come by. You can’t just call the IRS and ask for a deal. This option is to fill out IRS forms, provide financial information, and generate an offer amount.

Option 4: Contact a tax professional and / or attorney who specializes in tax

Overall, investors should meet with a tax advisor (CPA or attorney) so that a professional can give you the best possible advice on your individual tax situation. Remember that there are solutions.

Christopher Rogers, Esq. is Senior Tax Partner at Capital Fund Law Group, where he advises clients on investment fund formation, securities law, corporate law and taxation. Mr. Rogers also provides advice on structuring, setting up, and adhering to hedge funds, private equity funds, real estate funds, and other alternative investment vehicles, such as: B. digital assets. For more information on Mr. Rogers and the Capital Fund Law Group, please visit their website at: https://www.capitalfundlaw.com/

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.

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