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Co-founder at Everdragons2, SoloKeys. Former security at Pinterest.
A couple of years ago I published an article titled "Crypto Taxes for Dummies" to describe some subtleties with taxes and transacting cryptocurrencies. This is the year of NFTs, so it's worth revisiting the same topic with a focus on NFTs. I'm covering the US and this is not financial nor tax advice.
Taxes are amazing in their simplicity. In the rest of this article, we'll explain that: if you sold an NFT, you have to pay taxes; if you bought and sold an NFT, you have to pay taxes; and if you just bought an NFT… you have to pay taxes.
Let's recall the golden rule.
In the US, you have to evaluate every transaction at the time of trading, both 1) from crypto to USD and also 2) from crypto to crypto. If you realize a capital gain, you have to pay taxes on it.
To be crystal clear, let’s take two examples.
Example 1. Selling from crypto to USD.
Say you bought 1 ETH at $2,000 in early 2021. Now in Oct 2021 you’re selling 1 ETH for $3,000 ETH. The capital gain is the difference $3,000 – $2,000 = $1,000 and you have to pay taxes on it.
Example 1. Selling from crypto to crypto.
Say you bought 1 ETH at $2,000 in early 2021 and in Oct 2021 you’re exchanging 1 ETH for BTC. If the value of ETH at the time the transaction occurs is $3,000, then the capital gain is $1,000 and you have to pay taxes on it.
In summary, it doesn't matter if the transaction is to USD or to crypto. All it matters is the price when you bought and sold the asset.
If this is clear then the rest of the article will be straightforward, in the sense that buying and selling NFTs from a tax perspective is just like any other crypto transaction. There are, however, some interesting details based on when transactions occurred, so let's take a deep dive!
Before we even talk about taxes, let's spend a moment to review how people talk about selling NFTs and what is really important to pay attention to, for tax purposes. In short, USD matters, the rest doesn't.
As always let’s make a few key examples.
Example 3. Selling NFT for more ETH, at higher price.
You bought a NFT for 0.1 ETH when ETH was $2,000, and then sold it for 2 ETH when ETH was $3,000. This is pretty easy, you paid $200 and sold for $6,000. You can proudly say you made $5,800.
In the example above, people often say they made 30x. But for tax purposes the relative gain doesn't matter, what matters is only the absolute gain of $5,800.
Things can get a little trickier when either you sell the NFT for less or the price of ETH is down… but to be fair what’s tricky is just that people resort to language tricks to highlight their successes and hide losses. Taxes are simpler: just calculate the absolute gain in USD.
Example 4. Selling NFT for less ETH, at higher price.
As before, I bought a NFT for 0.1 ETH when ETH was $2,000. ETH is up to $3,000 and I decide to sell my NFT for 0.08 ETH. I paid $200 and sold for $240. My capital gain is $40.
Example 5. Selling NFT for more ETH, at lower price.
As before, I bought a NFT for 0.1 ETH when ETH was $2,000. I sold it for 2 ETH, but the price of ETH dropped to $1,000. I paid $200 and sold for $2,000. My capital gain is $1,800.
What’s curious about the last example is that, if you ask people, many will proudly say that they made 20x (from 0.1 ETH to 2 ETH), while in USD the gain is 10x. In any case, for tax purposes, the relative gain doesn’t matter.
In summary, in all cases, all you need to know is how much you paid your NFT and how much you sold it for, in USD. The difference is your capital gain (or loss) and you have to pay taxes on that.
Before we continue with more examples on how to calculate the capital gain, it’s worth taking a pause to reflect on taxes.
NFTs are typically sold on the blockchain for crypto, not for USD. But next year taxes shall be paid in USD. It’s good practice to convert some of your gains back to USD to cover for future taxes, unless you're comfortable paying out of pocket.
Let’s repeat it in less than 140 chars:
Taxes shall be paid in USD. NFTs are sold for crypto.
Make sure to sell some crypto to cover for future taxes.
And how about an example?
Example 3, cont. Taxes.
In the example 3 above, you sold your NFT for 2 ETH when the price was $3,000, your capital gain was $5,800. Say taxes are 50%, you will have to pay $2,900. It might be smart to sell about 1 ETH immediately, so you’ll have the cash to pay taxes later.
We talked about selling, let's take a look at buying. When you buy a good you're typically taxed at the time of buying (VAT). When you buy financial instruments you typically aren’t taxed but are taxed later as a measure of your capital gain. When you buy art, depending on your job and status, you may be taxed or not for various reasons. What is an NFT then? Truth is, I’m not sure, and until further clarification, I'm picking the most technically accurate definition.
Buying or minting an NFT means making a transaction on the blockchain, i.e. trading ETH for the NFT. Therefore, as any other transaction, there might be tax implications.
The following example is very important. It shows that just by buying an NFT, even if you’re still holding it, you may have taxes to pay.
Example 6. Buying an NFT with existing ETH.
In early 2021 you bought 1 ETH at $2,000. Now, in Sep 2021 you’re buying an NFT for 0.1 ETH when the price is $3,000. You’re making a 0.1 ETH transaction. You paid $200 for these 0.1 ETH, they're valued at $300 now, your capital gain is $100 and you'll have to pay taxes on that.
It gets even worse if you were holding ETH since a while… let’s take a look.
Example 6b. Buying an NFT with existing ETH bought quite a while ago.
Say you bought ETH a few years ago when it was very cheap, maybe $100. You can now pride yourself and buy what are -on paper- very expensive NFTs. With ETH at $3,000, you can buy a 10 ETH NFT because for you -in old money- that’s just $1,000. BUT… You're making a transaction of 10 ETH, today that's worth $30,000. Your capital gain is $29,000 and you have to pay taxes on it… it might be almost $15,000 in taxes!
Scary, uh!?
Well, the next example hopefully will alleviate some concerns. Say there’s a really cool NFT you want to buy, and either you don’t have ETH or you don't want to use your existing ones (perhaps for tax reasons.
Example 7. Buying an NFT with USD.
There’s an NFT for sale for 0.1 ETH and ETH is at $3,000. You purchase some ETH in USD and very soon after buying the NFT. Let's ignore gas and other fees for a moment. If you buy 0.1 ETH from USD, you pay $300. Then you make a transaction of 0.1 ETH to buy the NFT – at the current price, that transaction is valued at $300. There's no difference, the capital gain is $0. Therefore, there's no tax implication for buying an NFT "directly" in USD (or at least it’s negligible).
When you go into the details and start considering fees and the difference in time between the transactions USD to ETH and then ETH to NFT (it could be seconds or it could be a few days), things can get more complex, I’ll leave them to you as an exercise.
The takeaway of this section is to be aware that the sole act of buying an NFT may have tax implications. Taxes may be high if you're using an old reserve of ETH and are likely close to 0 if you're buying your ETH right before the NFT.
We talked about selling first and then zoomed in on buying. We learned that a particularly scary situation is when you’re buying with an old reserve of ETH vs just buying in USD. Let's put everything together in two final examples.
Example 8. Buying & selling for who had ETH.
In 2019 you bought 1 ETH for $100. In early 2021 you bought an NFT for 0.1 ETH when the price was $2,000. Recently you sold it for 2 ETH when the price was $3,000.
When you sell the NFT, it’s good practice to sell some of the earnings to USD to cover future taxes.
Example 9. Buying & selling for who's new to ETH & NFT.
In early 2021 you bought 1 NFT for 0.1 ETH when ETH price was $2,000, buying in USD. Then you sold the NFT for 1 ETH when the price was $1,500. Then bought 2 more NFTs, each for 0.5 ETH at the same ETH price of $1,500. Now, in Oct 2021, you sold 1 of the two NFTs for 2 ETH when the price was $3,000. You still hold the second NFT.
Because everything is short-term capital gain, it's easier to add everything up. In 1 year you realized a capital gain of $6,550 on which you have to pay taxes.
Note that the capital gain is higher than what you sold your last NFT for… sure, you still own an NFT, but to repeat one last time, it’s good practice to sell some of your ETH and account for future taxes!
This was a lot of numbers! And for just 1 NFT!! If you did many transactions and are looking for a tool (for crypto in general) I can recommend CoinTracking or ZenLedger. I sincerely hope this was useful and best of luck for the next tax season, to myself included. 😃
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