From the hype of Bored Ape Yacht club to the depths of crypto winter - NFT losses are estimated at around $25 trillion since it all came crashing down. But there might just be a silver lining in your tax bill. Learn how to use NFT losses to pay less tax with Koinly.
The obvious question is "why would I ever deliberately sell an NFT at a loss?"
Well, the answer comes in the form of tax loss harvesting.
You can learn all about tax loss harvesting in our guide, but in brief, tax loss harvesting is a strategy whereby investors realize losses deliberately by disposing of their asset (by selling, swapping or spending it) in order to utilize those losses to offset against gains and reduce their overall tax liability.
In the current market conditions, many investors have decided to cut their losses on held NFTs and recoup at least some of it back in the form of a tax benefit.
But if you haven’t spotted it yet - there’s a key problem with realizing losses on illiquid NFTs, in that for some NFT projects, it’s become extremely difficult to realize your loss by disposing of your asset when no one wants to buy your NFT.
Fortunately, you have options. In Koinly's NFT Tax Loss Harvesting Guide we'll show you how to dispose of your worthless NFTs to reap the tax benefits.
Follow these steps to dispose of your worthless NFT to realize a loss:
Let's look in-depth.
Knowing when to cut your losses isn't always easy, while limit and stop orders help managing gains and losses for tokens and coins, this is far less available for NFTs.
With NFTs, it generally all comes down to floor price. A floor price is the lowest price for a given NFT collection. If the floor price has plummeted way below the ATH, it may recover, but it's often a sign the hype train has run out of juice.
You can also look at this in combination with the bid/ask spread to see how liquid the market for your NFT is. In general, the wider the bid/ask spread, the more illiquid the market may be.
It will also depend on your specific circumstances. If you have no gains to offset this year, and think there's still a possibility your NFT may recover some value, hodling might be the right choice for you as you have no urgency to realize your loss. Meanwhile, if you've got gains, realizing your loss ahead of the end of the financial year may be more beneficial for your situation.
Use a crypto portfolio tracker like Koinly to help you keep track of both your realized and unrealized gains and losses.
To realize your NFT loss, you need to dispose of your NFT from a tax perspective. The normal ways to dispose of a crypto asset include selling, swapping, spending or (depending where you live), gifting it. Of course, for NFTs many of these aren't an option, so you can work through your options to figure out the best disposal route:
If your NFT market is still liquid - this is the easiest way to realize your loss, even if you're selling your NFT for effectively nothing.
Another important note here is we recommend listing your NFT on a marketplace, as opposed to making a P2P trade. This is because of what's known as an arm's length transaction in the tax world. An arm's length transaction refers to a transaction in which buyers and sellers act without influencing one another and it's easier to understand with an example.
Let's say you and a friend both have an NFT you wish to dispose of o realize a loss - so you decide to trade NFTs with each other in order to realize your losses. This wouldn't be viewed as an arm's length transaction. Both have motives in their sale and purchase, and they're influenced by each other. In these instances, the experts say this kind of transaction doesn't meet the requirements for an arm's length transaction and as such, you'd not be able to reap the tax benefits.
Many tax offices view gifting as a means of disposing of a capital asset - including the ATO in Australia, the CRA in Canada and HMRC in the UK (unless you're gifting to your spouse). If you live in one of these countries, gifting your NFT to a friend, relative, or stranger, counts as a disposal and you'll be able to realize your loss.
Unfortunately, for investors in the US, this isn't the case. Gifts are tax free in the US, under $16,000 a year for 2022. And even if you gift over that amount, you'll still not pay tax unless you're over the lifetime gift allowance of $12.06 million for 2022.
Which is why if you're in the US with an NFT with an illiquid market, you might want to opt for the third choice.
Burn addresses have existed in crypto for some time to manage token supplies and more, but they're relatively new to the NFT market and popping up as a direct result of illiquid NFTs.
One such example of a project that allows you to effectively burn your NFT by disposing of it is Unsellable NFTs. Here's how it works:
Unsellable NFTs is just one project of many that has popped up to help crypto investors dispose of their worthless NFTs, and you should always do your due diligence researching any projects you'll connect your wallet to.
A word of warning though, some crypto tax experts are concerned that loss harvesting apps will not pass the economic substance test set by the IRS. This common law doctrine denies tax deductions when the related transaction lacks an underlying economic purpose - in other words, if you're using a dedicated app for the purpose of tax loss harvesting, you're not conducting the transaction for a meaningful or substantial economic purpose. As such, there is the potential risk that these losses would not be deductible against gains. A potentially safer alternative is to find a burn wallet to send your NFT to - like the standard ETH burn address.
In even better news, Koinly makes it even easier to track your entire tax liability.
With Koinly, you can track both your realized and unrealized losses and gains, helping you optimize your tax position for the financial year easily and ensure you pay the least amount of tax possible.
Theoretically yes - but note, the IRS hasn't issued any guidance around this yet so it's without precedent currently.
To realize a loss you can utilize, you need to make what's known as an arm's length transaction. This refers to a transaction in which buyers and sellers act without influencing one another. In other words, selling to a friend so you can claim a loss is not an arm's length transaction, while selling to a stranger on OpenSea would be.
No. The Tax Cuts and Jobs Act means casualty and theft loss deductions are not allowed, excluding in the instance of a federally-recognized disaster.
It's been a rough year for crypto investors in general, but perhaps for none moreso than NFT investors. As such, many investors are left with illiquid NFTs. These are essentially NFTs that cannot be disposed of easily, as the market demand to sell or swap them is low, or no, volume.
There are many NFT projects where the market is now illiquid – whether that’s due to a rug pull, as in the case of Frosties NFTs, or because the trade volume is so low after the hype that it’s impossible to sell your NFT on.
As many as you’ve got. For US investors, the IRS says there’s no limit to the number of losses you can offset against your capital gains for the year, however, you do need to offset your losses - particularly from NFTs deemed collectibles - in a particular order.