“The only difference between reality and fiction is that fiction needs to be credible.” - Mark Twain 

You’ve probably got that friend who talks non-stop about the world of non-fungible tokens (NFTs) and all the wacky-named cryptocurrency out there. 

And of course, they’re dying to tell you over and over any time you hang out how you can make a fortune overnight (too bad your friend isn’t virtual) … 

Still, it’s hard not to wonder what it’s all about. 

Can you actually make a fortune? Maybe. Others seem to have done it. But what they’ve also made is a heap of tax complications for themselves with (so far) little official guidance on how to report some of these big payoffs.

Well, here’s what we know so far from the IRS.

Significant ether

We live in an increasingly virtual world. So many things are shifting that direction: banking, education, social events (ever been to a Zoom wedding?), dating, photos, etc … Why should assets be any different? 

To a degree, they’re not anymore. Right now, the NFT (Non Fungible Tokens)  worldwide market is in the billions of dollars – the number of NFT buyers worldwide jumped more than tenfold from late 2020 to late 2021. Most so-called experts say there’s no limit to how big the market can get. 

Very nice. But what exactly ARE non-fungible tokens? 

NFTs are unique (that’s where “non-fungible” comes from) digital assets such as sports cards, artwork, designer sneakers – even, if you can believe it, recent plans for building an eight-figure yacht. They rely on the same technology as cryptocurrency; crypto itself has a worldwide market in the trillions of dollars. 

Somebody’s spending a lot of money on this stuff whether you consider it real or not. And when people start spending big bucks on something, the IRS perks up its nose. 

Nothing ‘virtual’ about the taxes

On most tax matters, the IRS quickly kicks out guidance on how taxpayers like you and I are supposed to behave. One trouble with NFTs and taxes is that there hasn’t yet been much guidance. 

Uncertainty is marshy ground to walk with Uncle Sam, who seems to have a cardinal rule: When in doubt, blame the taxpayer. 

Right now, taxability of NFTs – which rely on the new blockchain technology, essentially a network of specialized computers – hinges on how they’re defined. For the moment, the IRS leans toward treating them as a capital asset. 

So, dealing with NFTs can be taxable if you buy one and then sell it for a profit: sell within a year and you’re taxed at the short-term capital gains rate; sell after longer than a year and you incur long-term capital gains rates. Depending on your income, either can be quite a bite. 

Sell any asset at a loss, of course, and you can use the loss to offset other capital gains. We can help you with this. 

Janet, and our firm, are part of a Master-Mind group of other high-level accounting firms. Their primary vehicle for dealing with short and long-term capital gains, is real estate.

An even pricier formula for taxing your profits at sale will hold true if the IRS eventually decides that NFTs are “collectibles.” Classifying NFTs this way could also curtail using losses to offset asset gains – but this classification could be tricky for the IRS as they often use the word “tangible” to describe collectibles. Stay tuned. 

Follow the ‘money’

Also, let your friend know that authorities looking to stop money laundering are also ramping up regulations. Never an agency prone to fooling around, the IRS has come right out and said that both NFTs and cryptocurrency have the potential for “mountains of fraud.” 

People often buy NFTs with cryptocurrency, which Uncle Sam calls “a digital representation of value.” Types of crypto include Bitcoin, Ethereum, Litecoin, and Dogecoin. Blockchain, the underpinning technology of both NFTs and crypto, is essentially a network of computers that maintain a database or ledger listing crypto transactions. 

Crypto comes with its own special tax spin. Crypto is property for tax purposes, by the way. If you receive crypto as payment for a good or service, you report the fair market value. Keep in mind that crypto’s value can change and often (even every second!). 

Recently, the IRS turned up the heat on crypto deals resulting in a new checkbox right at the top of individual tax return forms. Yet another wrinkle: Does the “virtual currency” mentioned in that question on the 1040 include NFTs? 

Then there’s the reporting: Most platforms don’t issue IRS 1099 Forms with cost-basis information – it’s up to you to save the paperwork and often figure out how much money you made or lost. But, as with many things in the virtual currency tax world, this is going to change soon – and we’ll keep you posted on that too. 

If your friend’s constant ramblings about NFTs and cryptocurrency have managed to snare your curiosity, you’ll want to know how to manage the tax implications when you do decide to dabble in the virtual currency world. And because this is one of the murkiest areas of tax law right now, you’ll want to make sure you cover your bases. 

Keep your records!

BE THE ROAR not the echo®

Janet Behm
Utah Real Estate Accountants
(801) 278-2700