The Ultimate NFT Tax Guide 2023

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If you have bought, sold, traded, or staked NFTs in 2022, you might owe some taxes to the IRS, if you are a resident of the United States. The IRS released the Tax Filing Guide for the year 2022 on December 19th, putting forth new crypto and NFT tax guide. 

The term “virtual currency” has been replaced with “digital assets” grouping NFTs and cryptocurrencies together to avoid the box ‘0’ loophole on form 1040.

To file your taxes this year, you will have to fill out forms 8948, and 1099-MISC in addition to filling out form 1040.

I know it looks complicated, but bear with me because it isn’t. We will run through everything new there is to know about NFT taxation and break down the process of filing your taxes one step at a time. 

P.S. : We will also look at some strategies to minimize your NFT taxes.

So Let’s hop in…

What is the new NFT tax guide?

A new section titled “Digital Assets” on the 16th page of the Tax Guidelines Report explicitly states:

“Digital assets are any digital representations of value that are recorded on a cryptographically secured distributed ledger or any similar technology. For example, digital assets include non-fungible tokens (NFTs) and virtual currencies, such as cryptocurrencies and stablecoins.”

It is evident that the Internal Revenue Service (IRS) considers NFTs to be a form of property, similar to cryptocurrencies. In other words, disposing of digital assets, such as through a sale or exchange, may result in tax obligations, just like with any other type of property. This is because such transactions may result in capital gains or losses that must be reported to the IRS.

The recent mandate has provided a clearer understanding of NFTs and established a more defined framework for their taxation. The tax rate for NFTs is not fixed and may vary based on factors like mode of purchase, duration held, and amount of gains or losses incurred upon disposal. 

How to report your NFT taxes to the IRS?

To determine the amount of taxes owed to the IRS, you will need to itemize all of your NFT transactions on form 8949 and then use the standard deduction chart at the end of the form to calculate the tax due.

Form 8949: To Disclose all Digital Asset Transactions

Form 8949 is the first form you need to fill out once you start filing your taxes for the year. Form 8949 has been specifically designed to accommodate all digital asset transactions and assist with the calculation of taxes owed on these types of transactions.

Similar to how crypto transactions are taxed, NFT taxes are divided into two categories.

• Long-Term Capital Gains Tax
• Short-Term Capital Gains Tax

Any NFT that you have held for more than 12 months before disposal is taxed in accordance with the long-term capital gains tax rates, and NFTs disposed in under 12 months incur short-term capital gains tax.

Form 8949 is divided into two sections i.e., Part-I for Short-Term Digital Asset Transactions, and Part II for Long-Term Digital Asset Transactions. 

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Short-term capital gains tax varies from 10-37% based on your income level. Here’s the standard deductions table for short-term transactions:

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Long-term capital gains tax varies from 10-20% based on your income level. Given below is the standard deduction table for long-term transactions:

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Note that the IRS tax structure is progressive, and not all of your income is taxed at the same rate even if you fall in a higher tax bracket. 

Consider this example:

If Ruby made $30,000 in 2022 from the sale of digital assets, assuming a short-term transaction she falls in the 12% tax bracket. But the entire sum will not be taxed at 12%. The first $10,275 will be taxed at 10% and the remaining $19,725 will be taxed at 12%.

That’s how all taxes work in the US.

Form 1040: A Summary of Financial Gains and Losses

The Internal Revenue Service (IRS) has updated Form 1040, which is used by U.S. citizens to file their income tax returns, to specifically mention "Digital Assets" to ensure that all crypto and NFT transactions are properly accounted for when filing taxes.

The next step in filing your NFT taxes is summarising all your gains and losses and reporting the final tax calculated through form 8949 through form 1040. 

When you start filling out form 1040, you will face the following question on the first page of the form: 

‍“At any time during 2022, did you: (a) receive crypto as a reward, award, or compensation; or (b) sell, exchange, gift, or otherwise dispose of a digital asset?”

If you have been involved in any of the following activities during the year, you need to answer this question with a “Yes”.

• Received digital assets as payment for property or services provided.

• Received digital assets as a result of a reward or award.

• Received new digital assets due to mining, staking, and similar activities.

• Received digital assets as a result of a hard fork.

• Disposed of digital assets in exchange for property or services.

• Disposed of a digital asset in exchange or trade for another digital asset; Sold a digital asset.

• Transferred digital assets for free (without receiving any consideration) as a bona fide gift.

• Disposed of any other financial interest in a digital asset.

You can answer with a “No” if you’re:

• Holding a digital asset in a wallet or account.

• Transferring a digital asset from one wallet or account you own or control to another wallet or account that you own or control.

• Purchasing digital assets using U.S. or other real currency, including through the use of electronic platforms such as PayPal and Venmo. 

Section D of form 1040 deals with capital gains and losses. It is used for reporting any gains or losses incurred by the sale, exchange, or conversion of capital assets. It is important to note that involuntary conversions that lead to financial gains must be reported in this section.

Another relevant section on form 1040 is, Section A which deals with itemized deductions. Itemized deductions are expenses that you can add to your gross income to lower the taxable amount and save taxes. According to the IRS, itemized deductions include medical expenses, dental expenses, certain taxes, interest assessments, theft losses, and other expenses.

It’s important to note that itemized deductions only work when the sum total of the deductions is greater than the standard deductions offered by the government.

Form 1099-MISC: To Disclose Awards/Gains from Staking NFTs

Form 1099-MISC is used to disclose any miscellaneous income that’s above $600 received as rent, rewards and prizes, healthcare payments, crop insurance proceeds, and cash payments. 

Rewards from staking NFTs and cryptocurrencies are considered to be miscellaneous income by the IRS and must be reported under this form. NFTs collected as an in-game reward and disposed of via an in-game or secondary marketplace, are also liable to taxes and must be reported in this form.

Moreover, NFTs received via airdrops or as a gift are also considered to be a reward or a prize by the IRS and should be reported via this form.

How to minimize your NFT taxes(5 tips)?

In addition to itemized deductions, there are other strategies that can be employed to reduce the amount of taxes owed on NFT transactions. Here are 5 strategies you can use to reduce your tax obligations this year:

1. HODL, Don’t Sell

Buying an NFT, or receiving it as a gift and holding them in your wallet doesn’t attract any tax liabilities, you might need to report the transaction to the IRS, but the gains are only taxable when you liquidate them or trade them for some other asset. As already mentioned above, short-term capital gains are taxed at a higher rate than long-term capital gains, so a strategically sound approach would be to hold your NFTs for at least 12 months before disposing of them.

2. Buy NFTs with Fiat Currency

According to the revised tax guidelines, you’re not liable for any taxes if you “Purchase digital assets using U.S. or other real currency, including through the use of electronic platforms such as PayPal and Venmo.” Moreover, If you purchase NFTs using fiat currency, you’re not obligated to report the transaction to the IRS. 

3. Use NFTs for Tax Loss Harvesting

You can sell some of your NFTs at a loss and offset your taxable income against it. You can offset up to $3,000 worth of losses from NFTs sale against your capital gains in a year. This is called tax-loss harvesting and it’s a popular financial technique to reduce your taxable income from NFT sales.

4. Take NFT-backed Loans

NFT-backed loans are one of the best ways to cash in on your NFT gains without getting taxed. Personal loans are not taxable because they are not considered a part of your income. You can use your NFTs as collateral to get access to liquidity pools on platforms like SparkSwap and NFTfi. 

5. Use Software to File Taxes

Keeping track of all your digital asset transactions throughout the year and maintaining a ledger of instantaneous exchange rates is a (very)challenging task. If you fail to do so manually, you might end up misquoting the value of your transactions, resulting in an inaccurate tax report. Moreover, you can miss out on tax-saving strategies like HIFO accounting and tax-loss harvesting due to a lack of awareness. A smart step would be to leverage a potent crypto tax software like Kryptos. You can simply auto-sync all your crypto wallets and exchange portfolios with the software and it will generate a flawless tax report within minutes. And the best part is, it takes into account all local laws and tax-saving strategies to generate a financially-apt tax report.

FAQs

1. What is the NFT tax rate in the US?

The tax rate depends on the type of property being sold and the amount of profit the seller realizes from the sale.

For example, if an NFT is considered a collectible, such as a digital artwork, the sale of the NFT may be subject to a 28% tax rate on the profit. On the other hand, if the NFT is considered a capital asset, such as a security or investment, the tax rate will be based on the seller's marginal tax rate, which could be as low as 0% for those in the lowest tax bracket or as high as 37% for those in the highest tax bracket.

2. How does the IRS classify NFTs?

The Internal Revenue Service (IRS) in the United States generally treats non-fungible tokens (NFTs) as taxable property. However, the specific tax treatment of NFTs can vary depending on the nature of the NFT and the circumstances of the sale or exchange.

3. How are NFT gas fees taxed?

The IRS considers any gas fees paid while acquiring or selling an NFT as a capital expense. You can reduce your taxable profit by reporting the gas fees as an expense and writing it off against any gains you’ve made through an NFT sale. Adding gas fees to your cost basis can potentially decrease your tax liability when disposing of an NFT.

4. How are NFTs taxed?

NFTs are generally treated as intangible assets for tax purposes. When you sell an NFT, any profit you make is considered capital gains and is taxable. The rate at which you're taxed depends on various factors including your income and how long you've held the NFT. If you receive an NFT as payment, it's taxable as income based on its fair market value at the time of receipt.

5. How to report NFT on taxes?

To report NFT on your taxes, follow the following steps:

• Maintain detailed records of all your NFT transactions. This includes the date of acquisition, the date of sale, and the amounts in your local currency.
• Determine whether you've made a profit or incurred a loss. To do this, simply subtract your cost basis from the sale price. 
• Fill out the correct tax form. For instance, U.S. taxpayers would use Form 8949 and Schedule D with their Form 1040.
• If you receive NFTs as compensation for services or as a gift, you'd typically need to report this as income based on the fair market value of the NFT at the time of receipt.

6. How to pay taxes on NFTs?

Here are 5 steps to pay taxes on NFTs

• Determine your applicable NFT tax rate
• Make estimated payments throughout the year
• Consider deductions to save taxes
• Ensure you pay any tax owed by the deadline to avoid interest and penalties. 
• Consult a tax professional or use a crypto tax software

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All content on Kryptos serves general informational purposes only. It's not intended to replace any professional advice from licensed accountants, attorneys, or certified financial and tax professionals. The information is completed to the best of our knowledge and we at Kryptos do not claim either correctness or accuracy of the same. Before taking any tax position / stance, you should always consider seeking independent legal, financial, taxation or other advice from the professionals. Kryptos is not liable for any loss caused from the use of, or by placing reliance on, the information on this website. Kryptos disclaims any responsibility for the accuracy or adequacy of any positions taken by you in your tax returns. Thank you for being part of our community, and we're excited to continue guiding you on your crypto journey!