Filing Taxes for NFTs
This year, tax software developers and IRS agents may be faced with a larger challenge than they expected. Ron Shevlin, a fintech expert, just said on LinkedIn that a quarter of Gen Z has traded non-fungible tokens (NFTs). NFT gains are taxable income and NFT losses may be deductible. And after a few discussions with other people, I think that NFT taxes may take many filers by surprise this year. Many highly educated people still do not know that cryptocurrency trades are taxable at all, let alone NFT trades.
Meanwhile, NFT trades are recorded on publicly visible blockchains and the financial authorities of several countries, including the US and the Philippines, are tracking NFT trades. It’s well known that many players were earning income from Axie Infinity and similar games during the pandemic and in some cases they earned more than they would have at regular jobs. But many people also lost money on NFT trades, including most of the Gen Z traders. Reporting losing trades correctly is still important. Cryptocurrency brokerages can’t track off-platform trades and this affects the way they report transactions to the IRS.
If you transfer cryptocurrency to a regulated brokerage account from a decentralized exchange or non-custodial wallet, the brokerage will record that transfer with a cost basis of zero. That means if you transferred $1000 off the exchange and then sent $500 back, they may report the incoming transfer as a capital gain of $500 to the IRS even if you lost $500 on off-platform trades. So filing your taxes correctly could have a big effect on your taxable income.
Picking an App for NFT Taxes
Several cryptocurrency tax software apps are available right now. These apps include CoinTracker, an app that has a partnership with Coinbase. There’s also the app I’m currently checking out, ZenLedger, which has received several recommendations from financial publications. And there’s also TokenTax, which has a blog post up about Axie Infinity that explains the tax implications of playing the game. That’s effective content marketing because people who search for that topic are likely to need help with reporting their Axie Infinity transactions, including NFT transfers.
NFT tax preparation is a premium service. That’s important because you may have to pay much more money for tax preparation if you traded NFTs in 2021. For example, CoinTracker is free to use if you’re a Coinbase customer who only made a few trades on the platform in 2021. Several other apps charge fees in the $50 range if you only made a few trades. But cryptocurrency apps often charge $200 per year for premium tier access, and if you need to sign up for the premium tier to file NFT taxes you may have to pay $200 to do that.
ZenLedger originally classified NFTs as part of their premium service as well, but when I signed up to use the app myself, NFTs were no longer listed as a premium option and the fee was only based on the number of trades you made in 2021. That’s a big deal because it meant that I could pay a fee of around $50 instead of a fee of around $200. If you are willing to pay $200, though, you have several options. For example, TokenTax is relatively expensive but it’s positioned as the app for customers with the most challenging problems.
So you may be able to have your cryptocurrency taxes prepared for free if you only made a few trades using major brokerages such as Coinbase. The apps can import transactions from major brokerages without much difficulty, and they also support many major cryptocurrency exchanges. But these apps don’t support all exchanges, and the Ronin Dex (the Axie Infinity decentralized exchange) is not supported. For an unsupported exchange, you may have to upload a list of trades to the app in a CSV (comma separated value) file, which is similar to an Excel spreadsheet or Google Sheets document. Open Office doesn’t handle these documents correctly so I had to use Google Sheets to create the file before uploading it. That still didn’t work so I needed to get further assistance from the ZenLedger support team.
Customer Support Is Crucial
I’m still in the process of preparing my cryptocurrency taxes for this year, but Sumit the ZenLedger rep has been very helpful. Customer support is important because many of these apps have limited documentation, especially for anything involving NFTs. To file your taxes you need to upload a CSV file in the correct format and my original attempts to do this using ZenLedger didn’t go very well. The cryptocurrency tax apps do offer chat features where a rep will help you prepare your taxes, but even their premium app tiers are still considered do-it-yourself (DIY) services.
Hiring a CPA to prepare your NFT taxes could be very expensive. Some of the cryptocurrency tax apps have CPAs who can prepare your cryptocurrency taxes for you but charge thousands of dollars for this service, and I wouldn’t be surprised if an independent CPA charged a similar price. Most CPAs are not experts on NFTs and the CPAs that are have other options than individual tax prep work, including consulting and high-paying startup jobs.
The IRS guidance for NFTs is not very clear in comparison with other tax topics, probably because NFTs are so new. But it is clear that the IRS expects you to report your cryptocurrency and NFT transactions. And while cryptocurrency tax apps can handle simple transaction imports from major brokerages, recording NFT transactions correctly is a more difficult task. So it’s likely that you’ll need help from the app’s customer support team to prepare your tax documents and that means customer service is an important factor to consider.
It’s important to report NFT trades to the IRS even if you lost money on these trades. Cryptocurrency brokerages can’t track them so they might report gains on transactions where you lost money. And even if you’re not trading on a centralized exchange, NFT trading losses may still be tax deductible. Of course, if you earned money on NFT trades you’ll definitely want to ensure that you report any gains correctly. Otherwise, the IRS might audit you and demand additional taxes.
Cryptocurrency tax apps can automatically import transaction records from major brokerages and exchanges. But it’s more difficult to import transactions from decentralized exchanges into these apps, especially if these transactions involve NFTs. You may need to enter these transactions into a spreadsheet yourself, and you may also need help from the app’s tech support team. So customer service may be the main differentiating factor between the cryptocurrency tax apps right now.