And now the bad news.
With all the excitement surrounding cryptocurrency and non-fungible tokens, or NFTs, over the last few years, the idea of actually paying taxes on any of this stuff might not have occurred to some people.
However, it has most definitely occurred to the Internal Revenue Service and they have proven quite eager to collect.
Crypto Tax Bill Up to 37%
Peter Ritter, principal, Washington national tax with KPMG, said that the guidance from the IRS to date has been sparse, but it indicates that most crypto, including NFTs, are to be treated as property and not currency for federal income tax purposes.
"In addition," he said, "the guidance seems clear that crypto and NFTs can constitute capital assets if for example, they are held for investment."
Therefore, he said, it is possible to have long term capital gains, subject to preferential tax rates for individual taxpayers, with respect to crypto assets if they constitute capital assets and are held for more than one year.
The cryptocurrency tax rate for federal taxes is the same as the capital gains tax rate, which ranges from 10% to 37% for short-term capital gains in 2021 and 0 to 20% for long-term capital gains.
"The mere purchase of crypto with fiat, such as U.S. dollars, is not in it of itself a taxable event, nor is any unrealized (i.e., did not sell) appreciation on the asset," said Thomas Shea, a principal in the EY Tax Services group. "However, a sale or other type of divestiture does trigger a taxable event, and is the gross proceeds less your tax basis in the asset, generally including any associated fees and costs."
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Ritter noted that with crypto assets, including NFTs, it is possible to also earn income by reason of ownership, including through staking, liquidity mining, lending and other investment activities.
NFT Losses May Be Deductible
In many cases, and although not entirely clear, he said, taxpayers likely will have ordinary income from these activities, although in some cases gain or loss can be triggered.
"Of course, taxpayers need to consider state and local taxes too," Ritter said.
NFT sales made for some big headlines in 2021, as well as some big numbers, with sales totaling $25 billion, up from $94.9 billion the year before.
If you purchased an NFT with fiat, Shea said there is no taxable event.
"However, in order to purchase an NFT you likely did so with some type of cryptocurrency, he said. "If so, then you have a taxable event, and gain or loss to report on the crypto used for purchase, similar to a crypto-for-crypto exchange."
Joshua Tompkins, KPMG managing director, Washington national tax, said that exchanging property, such as an NFT, for cash or other property, including cryptocurrency, is a taxable event unless an exception applies.
"The gain subject to tax is equal to the difference between the amount of cash and/or fair market value of property received and the taxpayer’s basis in the NFT sold," Tompkins said. "If a taxpayer sustains a loss on the sale of their NFT, it may be deductible subject to certain limitations."
With NFTs, he added, taxpayers should also be mindful of special rules that might affect the amount of tax owed, such as the higher long-term capital gains tax rate imposed on the sale of “collectibles.”