One of the most common traps that crypto traders fall into is misunderstanding their responsibilities when it comes to taxes. While buying the dip and selling at all-time-highs is great, if your records aren’t straight, you’re going to find tax season a real headache.
The same goes for NFTs. The trading of NFTs involves assets that appreciate in value and the disposal of cryptocurrency that may also have risen in price since purchase. Both of these events are taxable in the US, as well as many other countries. Even minting an NFT from scratch may be taxable.
Whether you’re a hobbyist collector, part-time flipper, or professional NFT trader, staying on the right side of tax regulations is vital to your ongoing success in the crypto space. Here then, we’ve put together an NFT tax guide, explaining what needs to be considered when filing your taxes and how to file NFT tax records.
Tax triggering NFT activities
Unlike cryptocurrencies, non-fungible assets can hold individual, unique values of their own. Nevertheless, dealing with NFTs necessarily involves cryptocurrencies. Because of this, NFTs involve tax-triggering gains and losses.
- Buying NFTs: involves the disposal of cryptocurrency.
- Selling NFTs: involves the disposal of a digital asset.
- Trading NFTs: involves gas fees, and therefore the disposal of cryptocurrency.
If you decide to buy an NFT off a marketplace such as OpenSea involves the disposal of cryptocurrency. This is a taxable event and should be recorded for your files as the appreciation in the price of the crypto is considered a capital gain.
You only pay tax on the price increase of assets (such as cryptocurrency) when “realized.” Upon paying for an NFT, you are disposing of your asset and allowing its price appreciation to realize. This increase in the asset’s value is what is taxed.
For example, assume you were lucky enough to have bought 1 ETH for $500 a few years ago. Today, the price of ETH is $3000 (April 2022). You now use that 1 ETH to buy an NFT worth the same value. You effectively made a gain of $2500 ($3000 – $500 = $2500) and would pay tax on this.
Selling NFTs also triggers a taxable event. In this case, when you sell your digital asset, you will pay capital gains tax on any increase in value it has made.
Again, you do not owe any capital gains tax until you actually sell your NFT. Upon sale, however, you are disposing of your asset and realizing its gain. As such, you then owe tax on this appreciation in value.
For example, say you bought a Cryptopunk back in 2018 for 1 ETH. Again, let’s say this was worth $500. Fast forward to today and you’ve decided you and your Cryptopunk are ready to part ways with a buyer paying you 50 ETH when it is worth $3000, netting your $150,000. Your cashing-in of your Punk will have returned a profit of $149,500 which is considered a taxable that should be taxed.
While the act of creating an NFT may not necessarily be a taxable event in itself, at some point the creation of your token will require you to pay gas fees. These gas fees are forwarded to miners and stakers to cover the processing and security mechanisms used to maintain the network.
Paying gas fees means expending cryptocurrency such as ETH and therefore involves a taxable event. This is because, as with buying an NFT, the cryptocurrency you use to pay the gas fees may have appreciated in value since you acquired it.
What Tax forms will I need?
Bearing in mind, most NFT taxes are a result of crypto-to-crypto trades, 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 will show gains and losses upon cryptocurrencies flowing in and out of your possession. 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. Site: https://www.irs.gov/forms-pubs/about-form-1099-b
- 1099-K – Form 1099-K is for those who engaged in more than 200 transactions during the tax year or saw more than $20,000 in proceeds. This form specifically reports transactions to third parties involving credit cards. Again, this form should be issued to relevant parties automatically by crypto exchanges but can be requested manually if not. It should be noted that 1099-K does not factor in the cost basis of your crypto activity so your own records should be relied upon here. Site: https://www.irs.gov/businesses/understanding-your-form-1099-k
- 1099-Misc – Crypto exchanges such as Coinbase and Kraken issue rewards in the form of cryptocurrency for watching videos and learning about new tokens. If you’ve earned more than $600 worth of these rewards, you will be sent a 1099-Misc form for your records. This form will also usually detail staking rewards as well as airdrops. Site: https://www.irs.gov/forms-pubs/about-form-1099-misc
What 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 will want to refer back to your own records and the 1099-B forms issued by cryptoexchanges. Your own records are necessary for tracking the price you paid for NFTs and the source of the funds. This will allow you to determine appreciations and losses in value. There are also options to connect crypto wallets such as Metamask to tax software such as Koinly (https://koinly.io/). Website: https://www.irs.gov/forms-pubs/about-form-8959
- Schedule D – Schedule D is a summarization of the information you listed on Form 8959. Specifically, it details clearly 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 should be used to file the data from form 1099-Misc 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 pertinent to crypto and NFT trading. Be sure to answer the section asking: “At any time during 2021, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?” The question can be found on the front page of the form and should be answered “yes” if you engaged in crypto and NFT trading. If you simply held existing coins and tokens during this time and did not do any trading, you can answer “No.” Website: https://www.irs.gov/pub/irs-pdf/f1040.pdf
- Royalties and staking – Guidance has not yet been forthcoming by the IRS when it comes to royalties and staking. That being said, most accountants and crypto-tax specialists treat these as revenue and the value of them is considered income. Royalties could potentially be considered passive income, which would require the use of Schedule E (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 depends on the length of time you held the asset, your marital status, and your household status. This can be checked via the IRS’ website (https://www.irs.gov/taxtopics/tc409) which is kept updated with the latest information.