Taxes

NFT Taxes—The Article You Need to Read Now

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“The bookie will break your kneecaps. The tax man will break your soul.”  — Blitmap artist HighleyVarlet.

Since entering the world of NFTs back in the Spring, I have been incredibly fortunate to have stumbled into some incredible projects early one. Whether it was Punks Comics, the Bored Ape Yacht Club, Blitmap, 0xmons or Loot (for Adventurers), I have been incredibly lucky to have entered into many “blue chip” projects early on in the game. But there is one thing that I was not planning on: NFT taxes. This blog post is to serve as a cautionary tale for those who are new to the scene and a guide to offer some practical advice (please note: I am not an accountant and defer all accounting advice to a professional CPA; however, the aim of this article is to show you the importance in thinking about NFT Taxes now).

Implications Between Physical Item Taxes versus NFT Taxes

While I have a solopreneur style content marketing consulting business (and I’m happy to work with any web3 organizations looking for content marketing help), I also have a seasonal ecommerce business as well as an Amazon storefront. Those online businesses sell novelty goods and I have been doing this for around five to six years. And there is one thing I know from that business: I hate accounting.

Being trained as an engineer, it’s not the math in accounting that boggles my mind, it’s the concepts of where to put all those numbers. For that reason, I outsource all my accounting to a person I trust and who is an expert. But over the years, I’ve basically picked up that with these items it is essentially Gross Sales – Cost of Goods Sold = What I’m Taxed On. Now this is an over simplification, but in my world, I can always use some of the profits to purchase more physical items to kind of defer my tax burden.

That was my same approach to NFTs. In fact, I basically thought that if I started with a certain amount of money, I would basically be taxed at the amount of money that I pulled out at the end. For example, if I put in $1,000 to get started with NFTs and then were to pull out $5,000, I would be taxed on $5,000 – $1,000 = $4,000.

Boy was I wrong.

Around the beginning of September, I started seeing a lot of chatter in the Blitmap Holders channel as well as on Crypto Twitter about taxes. Seeing that I had made a fair amount of transactions, I decided to investigate the tax situation. And that is when I discovered a very troubling thing: NFTs are taxed on capital gains in the same manner as stocks.

What this means, at its core, is that every single gain you make in NFT land is taxed. This is different from the world that I’m familiar with, where I could buy $1,000 worth of trinkets sell them for $3,000 and then put that $2,000 profit into other trinkets to sell to decrease my tax liability. In the NFT world, if you bought a JPEG for $1,000 and sold it for $3,000, you immediately incur a taxable event on those $2,000 gains, regardless if you roll it into another NFT.

How I Got in a Bind with NFT Taxes: May Sound Familiar to You

Not realizing that early on caused a major, “Oh Shit!” moment on my end. Because rather than putting money aside for taxes, I just kept that money rolling into more and more NFTs. After all, this ship was taking off in the summer and I would have rather had my money in NFTs than just lying around.

And then the Labor Day Bear market hit. Sales started grinding to a halt and ETH was dipping. It was at this time that I met up a friend who flew into Texas so I could teach him about NFTs. We had a joint account that I was managing, and we decided to split it up so he could have his own NFTs and make his own decisions. It was an intense 2.5 day training session, but this slowdown definitely put some rain on our parade.

It was after I got home from the training that I started to research the taxes in earnest. I talked with several folks in holders and ended up using the software CoinTracking.info (more on that in a moment). It was at that time I realized the entire “capital gains” situation and had nearly a panic attack. I owed Uncle Sam a six-figured tax bill from NFTs.

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Now, I told you that we were in that bear market. ETH was tumbling down to below $3,000 (I remember it diving to $1,700 in the summer from a ATH of $4,000+ in the spring) and the JPEGs just weren’t selling. I had a heart attack. I did not have six figures in cash reserves to pay the tax bill. And it increasingly looked as though NFTs were going through a spate of illiquidity.

Furthermore, I was overexposed with Blitmap. I had almost 20 Blitmaps in my possession and was thinking that the news of The Blitnauts would help drive up the price. I did have a few other pieces I could sell (more on that later), but Blitmaps is my major bag. The Blitnaut minting was confirmed and would start a day later; I decided to see what happened and planned on selling a few Blitmaps to cover my tax bill.

And then it happened. The Blitnaut minting was opened and Blitmaps took a tumble, like most NFTs do after an airdrop. We went from a high of 30ETH down to around 10ETH (it has since come back up) during that bear market period. My major bags were a third of what they were, I had no real liquidity and a six-figure tax bill hanging over my head.

Being Controlled by Money Sucks

I have been very fortunate to never have been a slave to money. Since going on my own, I have always lived under my means; when I lost my job several years ago, we were OK with living on my wife’s salary and I was able to start up my business in earnest. I don’t care about fancy cars and things as much as just being able to have my time.

And now, my time was consumed by figuring out ways on how to get out of this tax debt. And it turns out I was not the only one coming to this realization. A lot of Crypto Twitter was talking about going to “tax jail.”

I, for one, don’t like messing around with the government and not paying my taxes. I realized that I had to come up with this money and didn’t know how. The only thing that was liquid was my Bored Ape Yacht Club NFT, but I didn’t want to sell that as I feel it will be the PFP that will be remembered and valued from this particular era. But man, selling that ape at 40ETH could really put a dent into what I owed.

I was just stuck. I didn’t want to act out of fear as I know I have blue chips. I felt then, as I do now, that Blitmaps will be back, and selling a chunk of them this early was foolish, especially since taxes are due in April. But having six-figures over your head is soul crushing.

I couldn’t sleep. I was in a state of constant stress and couldn’t do work. The Blitnaut launch was in full swing and, in spite of being a very active member of the community, I couldn’t enjoy this process with full gusto. This concern of money had me put the brakes on looking at other projects, and I completely missed out on CrypToadz, a project I would have surely aped in when I realized that this was GREMPLIN’s project, the artist behind the Nouns. That oversight cost me a pretty penny on the now 10ETH secondary of Toadz.

I was totally consumed. I felt stuck, hopeless and terrible that I put my family in this situation. Then things began clicking and I found my path forward, which I want to share with you if you are in a similar situation.

The Path Out of the Hellhole of NFT Taxes Debt

The first thing that I discovered and realized was “tax harvesting.” Because your capital gains are based on what you previously paid for an NFT (your cost basis), the first NFTs that you want to target to get rid of are those with the highest cost basis. Why? Let’s look at the three scenarios:

  1. You sell it and make money! This is great and the situation you want. But the money you are paying capital gains on is the Sales Price – Cost Basis. So let’s say you have an NFT with a cost basis of $10,000 and you sell it for $11,000, you get $10,000 that can be directly applied to the tax bill and you are left paying capital gains only on that $1,000 difference. (Note: I am using USD here because when you talk about ETH, you have to consider that the value of ETH goes up and down.)
  2. You sell it for exactly what you paid for. In this situation, you sell that $10,000 NFT for $10,000. There are no gains and all that money you sold it for can be applied to your tax bill.
  3. You sell it for a loss and “tax harvest” what you lost. In this situation, you would sell that $10,000 NFT for $4,000. You can use all that $4,000 on your tax bill in addition to taking that $6,000 loss against your total capital gains. Remembering the back-of-the-envelope calculation that a third of your gains are taxed, this $6,000 loss will reduce your tax bill at around $2,000.

So what I realized is that while I didn’t have any liquidity, I did have three assets where all that liquid ETH went to:

  • Night Moon Watcher Blitmap at 21ETH
  • ArtBlocks Squiggle at 12.8 ETH
  • 0xmons Dox at 18 ETH

I took roughly 51 ETH of gains that I had made and had it spread out over those three projects. Realizing that even if I had to sell all three for $0 (something unlikely), I could decrease my tax bill by roughly $50,000 to $60,000. This wasn’t optimal, but I started realizing I had a path out of debt and could avoid tax jail.

I also realized that I was sitting on 10,000 AGLD pieces from a Loot Bag and I had to make the tough decision to just liquidate that to get a little bit of peace. I then started doing some small flips and set aside some of the ETH for the taxes. I was reminded of a tweet from Blitmap Holder Jackson Dame:

While his philosophy may draw a little bit of eyerolls from NFT and crypto maxis, I think that Dame is spot on the money. Make sure you take care of your tax bill and any life decisions, put some ETH aside for long term holding and only then go back to the NFTs.

I then decided to sell Night Moon Watcher when Blitmaps were bouncing back. I got it because the Blitmap was a rare Earth III affinity that gave me access to the Earth Guild. But even though I am still bullish on Blitmap, I felt that this was the right time to put the Blitmap for sale. Afterall, had I been storing money aside for taxes, I shouldn’t have even had the opportunity to have purchased it. So, I priced Night Moon Watcher to sell, at 19.95 ETH. I was willing to take that 1.05 ETH loss (plus another 0.5 ETH in OpenSea fees) as just a lesson learned and to get a good chunk of money to pay down the tax bill. I was extremely fortunate that Blitmap legend ethventurer saw this Blitmap for how it was special and made the purchase—this collector has helped me out immensely and I wish them all the best and hope that the Blitmap moons for them!

So long Night Moon Watcher Blitmap #758, I enjoyed you while I had you. Special thanks to Blitmap legend ethventurer for making the purchase at 19ETH. You are a legend and I hope that this moons for you my friend.

Having sold the AGLD and the Night Moon Watcher Blitmap, I was in a solid spot. However, I wasn’t out of the woods. Selling a Blitmap means that I would pay higher capital gains on the sale because the cost basis is far lower. And I wanted to keep the Squiggle and the 0xmon because they do help me diversify my collection (plus Owen was working on an airdrop for 0xmons holders). But in seeing ETH creep up to an all-time high and seeing the NFT liquidity basically dry up, I remember Owen posting in the 0xmons Discord about a potential buyer looking to make an private purchase via Sudoswap.xyz (a permissionless trading platform I recently wrote about). Even though I really, really didn’t want to let go of the 0xmons NFT, I felt it was better to get close to my goal of being in debt to the government. I reached out to Owen and he linked me up with a buyer 0xBatata who purchased Doz for 23ETH. I was finally able to breathe a little more.

Some might think that I am foolish for letting Doz go before the 0xmons airdrop, but man, a good night’s sleep can be priceless. Thank you 0xBatata for the private sale—I hope that this 0xmon and the associated airdrop moons for you my friend!

To be honest, I don’t really know if I am completely out of the woods or not because all NFT taxes software I have evaluated just sucks, a technical term. This has also given me time to create NFTs to help ensure I don’t go to tax jail, such as this awesome one-minute animated short entitled The Bored Typist, featuring my ape Papa Ernesto BAYC #2207.

Check out The Bored Typist short film on OpenSea—sales go to get me out of tax jail!

Even though my Bored Ape Yacht Club NFT is probably the most valuable and liquid asset to get me out of this NFT tax hell, I think it would be incredibly foolish to part with right now. So rather than sell it, I felt I could tap into the incredible BAYC community and create a derivative to help fund my tax bill. That is one of the reasons that I have created The Bored Typists animated short—the funds from this 0.25 ETH NFT will go to paying off my tax bill (and maybe getting back my BAKC dog I sold early one, a major driver of the storyline in the short film that you should really watch now; I promise it is good!). It was particularly heartening when the official Bored Ape Yacht Club Twitter account gave it a shout out the other day!!

Remember Tax Harvesting Must Be Done in the Tax Year!

But I only have a certain amount of time, because if you are looking at selling those pieces as a tax harvest, you have to do that in the tax year to take that deduction on your capital gains. This means that there’s about three months left in the year.

I’m releasing this article now for several reasons. The first of which is that if you have not considered taxes, now is the time to think about them. You need to know what your liability is and make plans for how to pay them now. This is because of the second reason: the more people who realize that they have major taxes to pay is going to fuel a potential sell-off come November/December. This is a complete conjecture on my part and do-your-own-research with respect to this phenomenon; however, it could present some problems if you are trying to offload NFTs at that time to pay your taxes.

Again, I am not an accountant and you need to consult with one to make your tax preparations. However, if you have sold/flipped a ton of NFTs and are not liquid at the moment, it would be prudent to begin looking into your particular liability. And moving forward, it seems logical to set aside some money for your tax burden from every sale you win on.

Final Thoughts: All NFT Taxes Software is Woefully Inadequate

One parting thought is around the actual mechanics in performing the analysis to understand your tax burden. At this point in time, all the NFT tax software seems woefully inadequate. Most crypto tax software is focused purely on cryptocurrency and ERC-20 coins and this NFT explosion leaves many solutions woefully inadequate. I have purchased a year membership to cointracking.info, but you really have to audit line by line—it doesn’t handle 1155 tokens well at all and it seems that I’d have to go in and validate a number of transactions. There is not a “silver bullet” on the market at the moment.

I have been freaking out a little in just the notion of tax prep. But my friend Elodis had some sage advice. Use the tools in their current form to get an idea of what you owe in combination with identifying your biggest sales. For me personally, I am going to try to think of all my big wins that I’ve had, run the capital gains and then double that number. That should cover a majority of my tax bill and even give a little fiat to boot.

This also gives these crypto SaaS companies time to develop a product by April that is more robust. The beautiful thing about the block chain is that all the data is there. As Elodis pointed out, there will surely be a team that cracks this nut by April, and if not, I can then begin tackling all the transactions on my own in the New Year.

We Will Get Through This

This is new territory for many of us when it comes to tax preparation. We will get through this, but don’t get caught unaware. And if you find an amazing NFT tax service or a professional service that is reasonable, please be sure to reach out to me at @niftypins on Twitter to let me know.

Big shout out to all the folks who have sort of given me counsel and heard me out as I was figuring this out. There are too many to name by person, but rest assured, your conversations were incredibly helpful during this process. The goal of this article is so that newcomers don’t get to experience the shock of NFT Taxes like I did—please share with any and everyone so they don’t get screwed over from a lack of knowledge. Header Photo by Jon Tyson on Unsplash.

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