What crypto investors need to know about NFT tax changes

Crypto continues to have a rocky 2023, with one of the latest announcements being an ongoing lawsuit against Coinbase from the Securities and Exchange Commission. While the SEC continues to hammer virtually every crypto-native organization or service provider, there are other issues that investors need to keep in mind. Taxes are part of every business conversation, and rarely fun to discuss. Like it or not, taxes are an important topic for any investment or business decision; crypto-taxes and tax treatment continue to provide fertile ground for debate, discourse and wide-ranging conversations.

Although the Internal Revenue Service has continuously updated guidance, issued several online Q&A documents, and made changes to tax forms for US taxpayers, the tax situation surrounding crypto continues to be complicated. Straight forward crypto transactions, such as using bitcoin (or other crypto) for transactional purposes, are well understood from a tax perspective, but they represent only a small piece of the bigger puzzle. Areas that remain open to intense debate and conversation include staking, wrapped tokens, decentralized financial transactions and non-fungible tokens.

NFTs differ from other cryptocurrencies due to the fact that they represent unique and distinct individualized assets and that NFTs are linked to an external asset, whether virtual or physical. With recent news that the IRS is considering changing the tax treatment of NFTs, essentially taxing them all at the higher flat tax rate versus the lower capital gains rate, investors and accountants alike need to stay on top of these issues.

Let’s take a look at a few things practitioners should keep in mind when trying to advise clients this tax season.

The tax authorities take crypto seriously. A common and recurring complaint that has been leveled at tax authorities and other regulatory authorities is that there is a perception that the crypto sector has not been taken seriously, or treated on a similar basis to other asset classes. As the IRS has issued more comments, revenue rulings and other comments, it is clear that crypto has moved from a concern that was only the focus of technical experts to one that has definitely made it into the mainstream.

Putting aside the political commentary that continues to dominate the blockchain and crypto sector, the reality is that both institutions and individuals are embracing blockchain-based payments. It can take the form of crypto/bitcoin serving a wage function, crypto used as a medium of exchange on a daily basis, or retail investors looking to diversify a portfolio. Whatever form the implementation takes, the reality is that crypto continues to gain acceptance and adoption; The IRS and other regulatory agencies take note.

Crypto taxes are changing. Although the treatment of crypto assets from a tax perspective is relatively straightforward – crypto is treated as property and taxed when used as part of an exchange or other transaction – the fast-moving nature of crypto also creates several situations where a blanket treatment is not applicable. NFTs have had a dramatic impact on the crypto sector, and look set to continue to do so going forward. As crypto, even during the ongoing crypto winter that continues to put pressure on the sector, continues to be more readily accepted by both individuals and institutions, tax compliance and reporting must also keep pace.

As crypto-assets of all kinds become more readily available, the fact is that accounting and tax practitioners must keep up with these changes. Even if the proposed change for NFTs changes as a result of public feedback, the fact that such proposals have been advanced conveys the message that compliance and revenue enhancement are priorities for the IRS.

Tax practitioners must be proactive. Taxes are retrospective in nature, with individuals discussing and paying taxes on events that have occurred in the past. This seems unlikely to change – after all, it’s impossible to tax income before it occurs – but that’s no excuse for accounting and tax professionals to take a backseat to the decision-making process. Crypto taxes are already a complicated and fast-moving area, NFTs represent a differentiated subset of crypto in their own right, and changing tax rates and criteria will only further complicate the situation.

NFTs may have retreated from the headlines, but the tax conversation surrounding them is heating up.