One of the most common pitfalls crypto traders fall into is misunderstanding their responsibilities when it comes to taxes. While buying the dip and selling on all-time highs is great, if your records aren’t right, you’ll find tax season a real headache.
The same goes for NFTs. NFT trading includes assets that are increasing in value and the sale of cryptocurrency that may also have increased in price since its purchase. Both events are taxable in the US, as well as in many other countries. Even hitting an NFT from scratch can be taxable.
Whether you’re a hobby collector, part-time flipper, or professional NFT trader, staying on the right side of the tax rules is vital to your continued success in the crypto space. Here we have put together an NFT tax guide explaining what to consider when filing your taxes and how to file NFT tax information.
Tax Triggering NFT Activities
Unlike cryptocurrencies, non-functioning assets can contain individual, unique values of their own. Nevertheless, dealing with NFTs necessarily involves cryptocurrencies. As a result, NFTs generate taxable profits and losses.
- To buy NFTs: includes the removal of cryptocurrency.
- Selling NFTs: involves the disposal of a digital asset.
- Trading NFTs: involves gas costs, and thus the removal of cryptocurrency.
If you decide to buy an NFT from a marketplace like OpenSea, it means the removal of cryptocurrency. This is a taxable event and must be recorded for your files as the appreciation of the cryptocurrency is considered a capital gain.
You only pay tax on asset price increases (such as cryptocurrencies) when “realized”. When you pay for an NFT, you are relinquishing your assets and allowing the price increase to be realized. This increase in the value of the asset is taxed.
For example, say you were lucky enough to buy 1 ETH for $500 a few years ago. Today is the price of ETH is $3000 (April 2022). You now use that 1 ETH to buy an NFT of the same value. You effectively made a profit of $2500 ($3000 – $500 = $2500) and would pay tax on it.
Selling NFTs also causes a taxable event. In this case, when you sell your digital asset, you pay capital gains tax on any appreciation it has made.
Again, you don’t owe any capital gains tax until you actually sell your NFT. However, when selling, you alienate your assets and realize the profit. You will therefore owe tax on this increase in value.
Let’s say you bought a Cryptopunk in 2018 for 1 ETH. Again, let’s say this was worth $500. Fast forward to today and you’ve decided that you and your Cryptopunk are ready to part ways with a buyer who will pay you 50 ETH when it’s worth $3000, which will make you $150,000. Your redemption of your Punk made a profit of $149,500, which is considered a tax to be taxed.
While creating an NFT in itself is not necessarily a taxable event, at some point you will have to pay gas fees for creating your token. These gas fees are forwarded to miners and strikers to cover the processing and security mechanisms used to maintain the network.
Paying gas fees means spending cryptocurrency such as ETH and therefore involves a taxable event. This is because, just like buying an NFT, the cryptocurrency you use to pay the gas charges may have increased in value since you bought it.
Which tax forms do I need?
Keep in mind that most NFT taxes are the result of crypto-to-crypto transactions, for those in the US you can expect to receive tax reports from crypto exchanges for the past tax year.
- 1099-B – This summarizes your trading activity and shows gains and losses on cryptocurrencies flowing in and out of your holdings. Major crypto exchanges will issue this to you automatically or can be requested if not. It reports the dates and prices involved in buying and selling crypto. Website: https://www.irs.gov/forms-pubs/about-form-1099-b
- 1099-K – Form 1099-K is for those who completed more than 200 trades or saw more than $20,000 in revenue during the tax year. This form specifically reports transactions to third parties with credit cards. Again, this form should be provided to relevant parties automatically by crypto exchanges, but can be requested manually if not. It should be noted that 1099-K does not take into account the cost basis of your crypto activity, so you have to rely on your own data here. Website: https://www.irs.gov/businesses/understanding-your-form-1099-k
- 1099-Miscellaneous – Crypto exchanges like Coinbase and Kraken give out rewards in the form of cryptocurrency for watching videos and learning about new tokens. If you have earned more than $600 in these rewards, you will receive a 1099-Misc form for your records. This form usually also lists the wagering rewards and airdrops. Website: https://www.irs.gov/forms-pubs/about-form-1099-misc
Which form should I submit?
- Form 8959 – To report your NFT and crypto gains and losses, you will need Form 8959. To fill out the form, you need to refer back to your own details and the 1099-B forms issued by crypto exchanges. Your own data is needed to track the price you paid for NFTs and the source of the money. This allows you to determine valuations and value losses. There are also possibilities to link crypto wallets such as Metamask to tax software such as Koinly (https://koinly.io/). Website: https://www.irs.gov/forms-pubs/about-form-8959
- Planned – Schedule D is a summary of the information you provided on Form 8959. In particular, it clearly displays your gains and losses for each type of asset. Website: https://www.irs.gov/forms-pubs/about-schedule-d-form-1040
- schedule 1 – Schedule 1 must be used to submit Form 1099-Misc data, including staking, airdrops, and rewards. Website: https://www.irs.gov/pub/irs-pdf/f1040s1.pdf
- Form 1040 – Your main income tax return, Form 1040 has a section relevant to crypto and NFT trading. Be sure to answer the question section: “Have you received, sold, exchanged or otherwise disposed of a financial interest in a virtual currency at any time in 2021?” The question can be found on the front page of the form and should be answered “yes” if you are into crypto and NFT trading. If you were just holding existing coins and tokens during this time and not doing any trading, you can answer “No”. Website: https://www.irs.gov/pub/irs-pdf/f1040.pdf
- Royalties and stakes – There is as yet no guidance from the IRS when it comes to royalties and staking. That said, most accountants and crypto tax specialists treat it as income and its value is considered income. Royalties can potentially be considered passive income, which requires Schedule E to be used (https://www.irs.gov/forms-pubs/about-schedule-e-form-1040).
- Capital Gains Rates – As with any investment in the US, the tax rate you pay will depend on the length of time you owned the asset, your marital status and your family situation. This can be checked through the IRS website (https://www.irs.gov/taxtopics/tc409) which is updated with the latest information.