With the growing value of NFTs and the potential for abuse and fraud, governments and tax authorities have started developing strict laws and regulations on this asset type, making NFT taxes a hot topic. Logically, many business and individual NFT holders are looking for a reliable approach to handle this delicate matter, and one of them is to hire an NFT tax accountant. For those who need more insight, we’ve compiled this article with all you need to know about an NFT tax accountant.
Today, our world is filled with many types of investing opportunities.
The world of finance is indeed full of surprises and unforeseen benefits in the digital age. Take non-fungible tokens (NFTs) as an example. It’s common knowledge that NFTs have become an exciting investment option for many.
Of course, with more profits come more responsibilities.
With the growing value of NFTs and the potential for abuse and fraud, governments and tax authorities have started developing strict laws and regulations on this asset type, making NFT taxes a hot topic.
Logically, many business and individual NFT holders are looking for a reliable approach to handle this delicate matter, and one of them is to hire an NFT tax accountant.
For those who need more insight, we’ve compiled this article with all you need to know about an NFT tax accountant.
First, let’s briefly talk about NFTs and how they work.
Generally, we can group assets into two forms:
As the name suggests, you can exchange fungible assets (just like money) for other assets, goods, or services. You can trade them too.
Virtually, all types of physical objects, including diamonds, real estate, and even sports cards, count as fungible assets.
Non-fungible assets, on the other hand, are recorded on a digital ledger and cannot be exchanged. This goes back to the specific metadata and identifying codes that set NFTs apart from other tokens.
Each token demonstrates characteristics of individual ownership.
Since 2014, NFTs have flourished in the financial world. However, their popularity has risen in recent years, much like cryptocurrencies like Bitcoin and ETH.
NFTs have the potential to record everything from birth certificates to rap videos.
In other words, it's not possible to replicate them since they are primarily on digital platforms, such as original artwork or videos. Even social media posts can turn into NFT assets with significant value.
The prime example is Jack Dorsey's first tweet that sold for a little over $2.9 million last year. But that doesn’t really explain how NFTs work, does it?
Similar to cryptocurrencies, non-fungible tokens rely on the well-known blockchain technology.
Here are a few points we should make clear right off the bat.
NFTs and cryptos use the same code but are treated quite differently in the market.
For instance, coins like Bitcoin or Eth have equal value and are easy to swap or trade. However, you cannot exchange one NFT for another because each represents a different item with a different value, hence the word "non-fungible".
Hopefully, you now have a basic understanding of how NFTs work.
Of course, we’re well aware there are still many gray areas, and one of them is undoubtedly taxation and how NFT accountants can help. Let's get a closer look.
In essence, NFT accounting is similar to managing crypto taxes.
NFTs are merely taxed and treated like property. The distinction is if a taxpayer creates or just trades NFTs.
Creators must pay taxes the moment the NFT is sold, and any revenue is treated as regular income. Like other coins, people buying and selling NFTs must pay taxes while keeping long-term rates (capital gains tax) or short-term rates (income tax) in mind.
Like many other assets, you have to pay taxes when buying and selling NFTs. Of course, there are still many question marks around how the taxes would apply in every single situation.
While the IRS regulations about buying a car are more detailed and clear than trading tokens on the blockchain, there are still many similarities between the two.
The "motive to profit," timeframe and place of trading are all factors that the IRS considers when applying its tests and standards to financial transactions.
According to the IRS guidelines, coins like Bitcoin and ETH are not regarded as "cash" or "currency." Yet, there is a similarity between NFTs and cryptocurrencies in that their owners or "holders" count as investors possessing an asset.
Therefore, you could say that an NFT investment is similar to investments in things such as wine in certain aspects.
For example, when buying an NFT or wine, you keep it for some time, hoping its value grows over time. Once you sell the asset and the value growth is realized, you have to pay taxes on the amount of capital gain you make.
The best way to demonstrate how an NFT accountant handles taxes is to first show you how NFTs are taxed in different circumstances.
When you use crypto coins to buy an NFT, you also lose that coin.
This implies that in case of any growth in the coin's value, you must pay capital gains taxes. For example, let's say you spent 5 BTC to buy an NFT on OpenSea when Bitcoin sold for $10,000 ($50,000 in total), but you had originally bought the Bitcoin at $6,000 ($30,000).
Since Bitcoin's value has increased over time, you owe capital gains tax in the amount of $20,000, and here’s the math.
$50,000 - 30,000 = $20,000
If you sell NFTs directly or through an exchange, you must pay capital gains tax if the NFT's value goes up. The tax rates depend on how long you owned the asset:
Let's use the same example. You spent 5 BTC at $10,000 each ($50,000 in total) to buy an NFT. But, after a while, you sold it for 5 BTC at $20,000 each ($100,000 in total). Now, this means that you owe $50,000 in taxable gains.
(The math looks like this: $100,000 - $50,000= $50,000)
Web3 has created an entirely new kind of online gaming environment where players buy and hold in-game assets (tools, avatars, weapons, etc.) and convert them to other asset types. These games are sometimes referred to as "play-to-earn" (P2E) since players earn money by doing activities such as fighting and earning NFTs.
The main lesson to be learned from each game's mechanics is that because the majority of activities in a play-to-earn game involve crypto-to-crypto exchanges, they will almost always be taxed.
While obtaining in-game assets through network activities would probably be considered income, selling an in-game item for a profit counts as capital gains tax.
If your business is mainly involved in NFT trading, it's easier for the IRS to consider the activity as "trading" than if it were an individual buying and selling NFTs. That way, the IRS can tax those profits based on the corporate tax system.
If your business invests in NFTs, it would be reported as an intangible fixed asset for tax purposes. This is the equivalent of owning assets like trademarks and patents.
Regardless of how you earn profits with NFTs, you should be mindful of IRS rules and record your transactions in detail so an accountant can:
We briefly explained how an NFT accountant handles different tax situations. Of course, these examples were just that: examples. Reality is far more complicated and "gray" since NFTs have just entered the market.
Due to that lack of understanding that everyone on the market shares, many NFT holders consider hiring NFT accountants to stay ahead of the game.
Of course, some investors may assume that they can handle the taxes on their own. Well, not to burst their bubble, but they're wrong. Here are some other reasons you may need an NFT accountant.
NFT investors are familiar with many industry concepts you may be alien to, including:
Even if math is your thing, it may not be wise to calculate taxes yourself.
As mentioned before, NFT taxation is hard to grasp even for accountants and tax consultants who regularly work on tax issues relating to individuals, corporations, property, and other tax situations.
Given the complexity of NFT tax rules, only a small number of accountants and tax experts now provide NFT tax services.
It’s best to consult with a specialized NFT accountant regardless of whether you are a business or an individual. In addition to helping you get the best investment return, they will keep you safe from failing to comply with the harsh and intricate tax laws.
If you take every step with the advice of an expert, you can protect yourself against many risks.
Although NFT taxes and regulations are still evolving, tax authorities are working hard to determine NFT taxes as soon as possible.
Using software, you may manually upload the data from exchanges and wallets to the NFT tax software. You can use this to start gathering data on your NFT taxes. But, that won't do any good until you bring in an expert who can make sense of the data.
It’s important to reconcile the token balance with the portfolio balance in order to check data accuracy. Due to the complexity of NFT treatment, only an NFT accountant can identify and resolve issues like:
and other errors.
Compliance is surely the most pressing problem in an area like NFT taxation since governments and tax authorities are constantly modifying regulations and introducing new ones.
This means that every NFT tax situation can require a different accounting approach at different times. Every approach comes with different liabilities that you or anyone other than an NFT accountant cannot minimize.
A good accountant must stay updated on tax code changes, including new rules, elections, or deductions. Also, you can be confident that they will file your taxes in compliance with the most current tax rules, saving you as much time and money as possible.
Speaking of saving time and money…
Essentially, even the most basic NFT taxes are far more complicated than traditional taxes. Also, the more complex the tax procedure, the greater the chance of error, which may prompt the IRS to thoroughly audit your finances.
Professional NFT tax accountants have extensive knowledge on completing every challenging phase of the procedure, saving you from the many pitfalls down the road.
Also, it's not just a matter of experience or expertise. You may have already dedicated most of your time, staff, and money to work on your core business, meaning that you don't have extra time to do NFT taxes.
Even if you have received payment and there is an unchangeable record on the blockchain, it doesn't mean that your NFT accounting accurately reflects your finances on the blockchain.
Many businesses bulk feed transactions into the accounting software without even considering if they have gained the most from that data.
Of course, that's only natural since they don't understand how it can help with their taxes. A professional NFT accounting team has the knowledge to use the data and comprehend your contractual commitments to accurately calculate and distribute your royalties and revenue shares.
Also, when you consult with NFT tax experts when making leadership decisions, you can design revenue flows with a clear audit trail that can also confirm you are receiving the royalties, licensing fees, etc., from your NFT investments.
Back in April, the IRS and many foreign tax authorities (such as the HMRC) warned that the lack of clarity over NFT taxation could lead to crimes such as money laundering, digital fraud, and other financial crimes.
In a joint statement, they announced that "While the majority of cryptocurrency owners and those purchasing NFTs are doing so for righteous reasons, criminals look for any way to exploit new technologies. Cryptocurrencies and NFTs are not immune,"
As a result, they've spent more time and budget on recent audits and tax investigations, making it a point of concern for businesses.
Even a simple tax investigation might take months to complete, which can be pretty stressful. Remember that an IRS inquiry can occur at any moment. Additionally, with the recent spike in NFT value, the IRS is actively targeting NFT holders to generate tax revenue.
Now, sooner or later, you'll have to deal with your NFT taxes. It goes without saying that you need a reliable NFT accounting team to do that.
Our goal in this article was to explain all you need to know about an NFT tax accountant. We talked about what NFTs are, how NFT accountants tax them, and why any regular accountant won’t just be enough.
Now you know that there are too many complexities regarding NFT taxes, and they can easily create confusion and even compliance problems.
The help of a reliable NFT accountant can help you navigate through those issues. Using their skills, experience, infrastructure, and knowledge of the latest changes to tax laws, they can save you a lot of trouble.
Of course, with a wide range of accounting services on the market, you need a service provider with enough flexibility and affordability that matches your exact needs and budget. Luckily, that’s exactly what we provide at Lorenzo Tax.
Just contact us, and let’s get your NFTs in order.