If you are a little confused about how to manage your NFT and crypto assets, you are in very good company. Many Americans have turned to digital investments in recent years for a variety of reasons – including the appeal of decentralization or simply the expectation of higher returns.
While financial professionals should be familiar with the ins and outs of taxation on traditional investments, both crypto and NFTs are still relatively new territory. So new, in fact, that the IRS still hasn’t issued much guidance. For now, we know that these investments are subject to capital gains and income tax just like any other investment.
As we sort out the reporting requirements for these tricky taxable holdings, we’ll highlight 3 important learnings:
1. Staking income is taxable
Simply put, “staking” is to digital assets what interest-bearing accounts are to cash – except staking is a bit more (pun intended). Investors are locking up these assets for a set period of time in order to support the operation of the underlying blockchain. Prize? More cryptocurrency – and, sometimes, quite a bit.
We know that crypto is a notoriously volatile asset, making it a less-than-ideal choice for the faint of heart. But the potential for asymmetric returns may indicate a higher payout. And the IRS stands ready to do its share. Know that reporting requirements apply to any income for NFTs and crypto-related activities, including mining, exchange, airdrops, or any other form of receipt of virtual currencies. So, even if you haven’t received a 1099, you still need to report it.
As always, the tax you pay is based on the difference between the purchase price and the selling price of the property when you sell it. Naturally, some argue that these assets should not be taxed because the staking rewards come in the form of fledgling cryptocurrency coins. Their rationale is this: manufacturers are not taxed on the value of a product unless they Sell This.
Which is an interesting perspective. But until the IRS agrees, No Reporting these types of transactions – especially large transactions – is not the wisest option unless you are open to the risk of being hit with penalties when they discover your defaults. Be sure to maintain records of your transactions for anything involving NFTs and cryptocurrencies.
2. Wash sale rule does not apply
On to the better news. Unlike traditional securities, crypto and NFTs are not currently subject to the wash sale rule. A wash sale is when you sell a traditional security, such as a stock, bond or mutual fund, for a loss so that you can claim the loss on your tax return — and then repurchase the security. The IRS considers this transaction “laundering” and will disallow the loss if it is repurchased within 30 days of the sale. This law is designed to prevent investors from gaming the system.
But what’s interesting is that, at least for now, the wash sale rule does not apply to NFTs and cryptocurrency because they are not yet considered securities under the IRS code. Let’s say you lose money in NFT or crypto and want to sell to take advantage of that loss during a market downturn. In that case, you can go ahead and repurchase it immediately (but know that banning crypto wash sales is on the legislative agenda – so this loophole may soon be history). For now, you can use these losses to offset up to $3,000 against capital gains and/or other income. Any unused loss from a prior year can be applied to offset income in future years.
3. Securing Your Investment
Consider a custodial exchange for your NFTs and cryptos. After last year’s FTX debacle, many investors wanted an alternative to holding digital assets on a cloud-based exchange. Some put their crypto in “cold storage” – a hardware wallet that is stored offline, making hacking difficult. Unfortunately, it also makes tax collection difficult – it’s an extra (often frustrating) step to take when you need to sell your digital assets.
One option is to look for an exchange that can also act as a custodian – a holding place more accessible than cold storage but more secure than a regular crypto exchange.
Custodians provide a secure environment to store and manage digital assets. Exchanges (like FTX) are digital trading platforms where traders can buy and sell. Custodian offers a variety of security features including advanced encryption technology, cold storage, and two-factor authentication. Given that these platforms are still subject to risk and fraud is still possible, custodians are also insured, regulated and audited, which provides some recourse.
The views and opinions expressed here are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.