For many, tax season is finally behind us. While it’s nice to take a breath, it’s also never too late to start thinking about next year’s filings — especially if you continue to invest in NFTs and crypto. Whether you’re in that group, or filed for an extension and still have time to submit your information, this guide will help you take a closer look at your crypto and NFT investments, including the potential tax implications associated with capital gains, losses, and charitable crypto donations.
NFT purchases and subsequent sales
Joe Biden’s $1.2 trillion infrastructure bill, which goes into effect in 2023, requires crypto exchanges to issue a 1099-B form that notifies the IRS directly of crypto transactions that exceed $10,000. This will help keep exchanges and investors accountable for their holdings. NFT holders are no exception to this new requirement, as the vast majority of NFT purchases are made with crypto or fiat.
Indeed, any taxes tacked onto the initial purchase of an NFT are likely to increase when you convert, transfer, and/or sell one. These calculations will change based on how much the holder has gained (or lost) and how long they may have held the asset — whether short-term or long-term.
For long-term investors, an individual could expect a zero to 20 percent tax rate, while a short-term investor (who has held the asset for less than a year), would still be subject to capital gains which are taxed as ordinary income at a 31 to 37 percent rate – depending upon the tax bracket they fall under.
In 2021, NFT sales reached almost $25 billion, compared to just $94.9 million in 2020. So, in the event an individual held an NFT for fewer than 12 months, they would likely have yielded some type of profit, triggering capital gains taxes.
For example, let’s say an investor purchased CryptoPunk #4156 for 2,500 ETH (or $10.2 million as of November 2021). The potential capital gains tax on the NFT would be around 31 to 33 percent, or $3.3 million. How about a smaller purchase of around $700? That transaction could yield close to $230 in additional taxes.
This year’s newly revised IRS form requires taxpayers to “check a box” as to whether they’ve transacted with crypto during the tax period. It may also leave taxpayers scratching their heads as to which transactions they are supposed to report for the 2021 tax period.
Another consideration is how crypto philanthropy has become a new phenomenon for consumers. Crypto philanthropy differs quite a bit from traditional charitable giving. We’ve seen a sharp rise in “intentional charitable donations,” as today’s generation is focused on how they can make the most impact for organizations they deeply resonate with.
The COVID-19 pandemic and ongoing geopolitical crisis in Ukraine have been perfect examples of how today’s generation’s spending habits have changed, positively impacting these communities in need. Crypto donations have created a bridge for donors to address hurdles, such as a nonprofit’s inability to receive funding due to government restrictions.
Perhaps one of the earliest case studies for crypto donations is WikiLeaks, which in 2010, was blacklisted by U.S. payment processors including Visa, Mastercard, and PayPal from receiving funding. Thanks to the immutable nature of blockchain technology and the speed by which crypto transactions are facilitated, today’s generations have turned an exciting eye toward philanthropy. As of today, WikiLeaks has continued to thrive due to its consistent receipt of millions in crypto donations.
Over 1,300 nonprofits accepted crypto donations in 2021, which are considered tax-deductible in the U.S., among other countries. However, how can taxpayers still get that tax-deductible write-off for donations they made in crypto or NFTs?
One of the more advanced forms of charitable giving comes in the form of donor-advised funds (DAFs), which are traditionally recognized by the IRS as ‘charitable contributions.’ A DAF, according to the IRS, is a separately identified fund or account that is maintained and operated by a 501(c)(3) organization, known as the sponsoring organization.
Each account is composed of contributions (cash, securities, crypto) made by individual donors. Once a donor makes a contribution to a DAF at a public charity, the organization takes legal control over it — while the donor retains advisory privileges with how those funds are distributed and invested.
The appeal behind these accounts is the immediate tax deduction a donor is able to take. As of last year, the average donor-advised fund account had $163,000, according to the National Philanthropic Trust (NPT).
Examples of notable DAFs include Fidelity Charitable, Schwab Charitable, and Vanguard Charitable. Fidelity Charitable reported that last year was the largest ever for crypto donations, where 45 percent of crypto investors donated to charities in 2020, compared to 33 percent of general investors.
For those who requested an extension on their tax reporting for 2021, there are perhaps opportunities for taxpayers to keep searching for those donation receipts. According to tax attorney Jonathan Shugart, one of the biggest issues he has seen over the past year is consolidation of receipts.
“Most people don’t report all of their charitable contributions at tax time, because they are not able to track down all of their receipts,” Shugart tells nft now. “If you do your charitable giving through your DAF, you have one receipt for all of your giving — no matter how many [public] charities you make grants to.”
Shugart is also the founder of B Charitable, an Alabama-based 501(c)(3) that is backed by the IRS and serves as one of the few charitable giving platforms that support any entity recognized by the IRS as a public charity while harnessing the tax advantages of both a charitable contribution and crowdfunding campaigns. Through the platform’s crowdfunding infrastructure, donors can create charitable campaigns in which they encourage their social influence to donate to the charities that resonate most with them.
According to Shugart, right now is the perfect time to be having conversations about crypto donations, specifically when a donor still wants the asset they just donated — a conversation that he says rarely happens. He presented the following example where a donor can repurchase the asset with the cash they would have contributed to the charity:
“Let’s say you have $10,000 that you want to donate to a charity. Let’s also say you have an additional $10,000 in bitcoin that you purchased for $1,000. Traditional wisdom says to ‘keep the bitcoin,’ and use your cash to support the charities that you care about. Alternatively, you can contribute the bitcoin to your DAF, where [we] liquidate the asset and put the proceeds in your fund for you to grant out to your favorite charities. In this scenario, nobody pays the capital gains tax on the sale of the asset, since B Charitable, a public charity, is who sold it. The charities receive more, and you still have your cash.”
But for those who may still want their bitcoin, Shugart says you can purchase more with the cash they would have donated to the charity, because their basis becomes the new purchase price — in this case, $10,000.
Keep your eyes on the ‘ACE Act’
It’s possible that DAFs as we know it could change following February’s introduction of the Accelerating Charitable Efforts (ACE) Act into the House of Representatives. The act aims to change federal law with respect to how quickly funds donated to donor-advised funds are made available to working charities, along with incentives for speeding up donation timelines.
However, many nonprofits have spoken actively against the ACE Act, arguing that now is not the time to be restricting charitable giving vehicles — given the COVID-19 pandemic and what we now know about the geopolitical crisis in Ukraine.
In short, just as the NFT market is constantly changing, so too are the laws and regulations that surround it. Staying informed is the best way to keep up with the dynamic nature of the space, and ensure you’re always getting what you’re owed during tax season.