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Think you know how NFT taxes work? Try getting a write-off

2021 was the year NFTs became mainstream. And that means as Tax Day on April 18 looms, all those new NFT buyers may find themselves dealing with thorny questions they’ve never faced before: How exactly does one file taxes on NFT sales? Or what if I donated an NFT and want to take a write-off? (Don’t take a shot every time NFT appears in this story; you won’t survive. Or maybe that’s the only way you’ll make it to April 18. We don’t judge.)

The IRS first offered guidance on virtual currency transactions in 2014. That’s offered some basis for interpreting the rules around NFTs, but there are many unanswered questions. As a result, NFT taxes remain blurry to many, including accountants.

While the Internal Revenue Service hasn’t issued specific tax guidance for NFTs, the general consensus is that NFTs are taxed as collectibles. For NFT creators, the income generated by selling one would be taxed as ordinary income, with a rate varying between 10% to 37%, in addition to a 15.3% rate for self-employment taxes.

For traders and investors, taxes on NFTs are broadly similar to buying and selling stocks — albeit at the significantly higher rate for collectibles. Since the NFT craze only really started in August, most new traders will only have short-term gains if they made a profit, which are taxed as ordinary income. Early adopters could qualify for long-term gains on NFTs they held for more than a year, which would be taxed at a 28% rate for collectibles. High-income individuals might also pay a 3.8% net investment income tax. Losses on NFTs could offset other capital gains — but not if they’re held for personal use. What does that mean for NFTs? It’s hard to say without official IRS guidance, but you might have a problem if you just bought that Bored Ape to show it off on your Twitter profile.

Tax guidance seems to get even more complicated for those who want to give an NFT to charity and take a write-off. Donating an NFT without knowing exactly what the organization you donated to is going to do with it in the next few years may very well backfire.

When NFTs are donated to a 501(c)(3) charity, they’re usually eligible for tax deductions. Charles Kolstad, a partner at international law firm Withers, said that issues arise when the recipient of the NFT donation isn’t clear on how they’re going to use it due to a “related use” provision in IRC 170(e) of the tax code.

“Typically, when someone gives a piece of real art to a hospital, we make sure the hospital has that piece of art in the hallway or in waiting rooms so that it’s using it in its overall business,” Kolstad told Protocol.

He added that in addition to the requirement to demonstrate a related business use, if the recipient of an NFT sells it within three years of the gift, then the donor will have to report some of the resulting profit as income and therefore pay income tax. That may be part of why selling or auctioning off NFTs, with the cash proceeds donated to charity, seems to be more popular than donating NFTs directly.

Austin Woodward, CEO of crypto tax accounting firm TaxBit, told Protocol that while he thinks traditional tax guidance for collectibles provides a fair amount of direction for how to treat the taxation of NFTs, there are plenty of nuances specific to NFTs that haven’t been addressed, such as minting fees, gas fees and royalties.

The IRS has yet to issue official guidance on whether or how transaction fees in digital assets factor into the cost basis of an asset. Much of the burden in the tax filing process still falls on the taxpayer, giving rise to third-party services such as TaxBit and CoinTracker.

But Woodward is optimistic that the IRS will issue guidance down the line.

“They don’t want to kill digital assets, they don’t want to kill crypto. This is an asset class that they just want people to be tax-compliant,” Woodward said. “I do think we’re going to see more and more guidance around the corner.”

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