Using NFTs For Tax Loss Harvesting: What You Need to Know
Are you worried about paying high taxes on your NFT investments? Tax loss harvesting is a popular strategy investors use to reduce their tax liabilities by offsetting gains with losses. However, with the rise of NFTs and other digital assets, traditional tax loss harvesting strategies may not apply.
Last Updated: May 3, 2023
In this regularly-updated guide, we'll explain what tax loss harvesting is and how you can apply it to NFTs. We'll explore the benefits of this strategy, including maximizing tax savings, reducing future capital gains, and increasing cash flow efficiency. We'll also discuss the challenges of NFT tax loss harvesting, such as the wash sale rule, and identifying qualified NFT transactions.
What is Tax Loss Harvesting?
Tax loss harvesting is a tax-saving strategy that involves minimizing capital gains taxes by selling investments that have lost value. Selling in this way allows investors to use the losses to reduce their overall tax burden.
In other words, when you sell an asset for less than its original purchase price, you incur a capital loss in your portfolio. You can then use this capital loss to offset capital gains in the same year, thus reducing your tax liability.
How does NFT Tax Loss Harvesting Work?
NFT tax loss harvesting works similarly to tax loss harvesting for cryptocurrency or traditional finance. When your non-fungible tokens (NFTs) lose value, you can sell them to offset any capital gains you've realized from other investments.
For example, if an investor bought an NFT for $10,000 and sold it for $15,000, they would have realized a capital gain of $5,000. However, if they later sold an NFT at a loss of $5,000, they could use that loss to offset their previous gain, resulting in no taxable gain.
According to the Internal Revenue Service (IRS), an investor can also use this method to offset ordinary income and future capital gains. You're allowed to offset up to $3,000 of ordinary income per tax year by harvesting your losses.
For example, if an investor bought an NFT for $15,000 and sold it for $10,000, they would have realized a capital loss of $5,000. If they had no additional capital gains/losses during the tax year, they could use that $5,000 loss to offset $3,000 of income on that year's tax return. They could also use the remaining $2,000 loss to offset future capital gains.
To qualify for tax loss harvesting, the sale of the NFT must be a "realized loss". In other words, you must sell it for less than the original purchase price.
There are also rules relating to the holding period which determine the investor's overall tax liability. So it's essential to consult with a tax professional or use a platform like ours to simplify the process.
Benefits of NFT Tax Loss Harvesting
Here are some benefits of using this tax-saving strategy.
Maximizing Your Tax Savings
By selling NFTs that have lost value, you can use the losses to offset any realized capital gains or income. These realized losses could cause a lower tax bill.
Future Capital Gains Reduction
By harvesting your losses in one tax year, NFT investors can reduce their potential capital gains taxes in the future. As we already mentioned, capital losses can offset capital gains in the future, reducing your overall tax liability.
Increase Cash Flow Efficiency
By reducing your tax burden, you can keep more money to reinvest in other avenues.
Challenges of NFT Tax Loss Harvesting
One of the biggest challenges of NFT tax loss harvesting is the complexity of digital and crypto assets. NFTs are still a relatively new asset type and it can be difficult to determine their value. This often complicates the calculation of capital gains and losses. Additionally, the IRS has yet to release specific guidance on the taxation of every type of NFT transaction, which can lead to confusion and uncertainty for investors.
Wash Sale Rules and Cost Basis Calculations
The IRS classifies NFTs and other digital assets as property, and not securities. Therefore, the wash sale rule that typically applies in traditional finance doesn't apply to NFTs. But, unlike TradFi, accurately calculating the cost basis of NFTs takes time and effort.
To calculate the cost basis, you need to know the value of the asset at the time you first obtained the NFT. If you did not purchase the NFT originally, this can be difficult to find out.
Identifying Qualified Transactions for Tax Loss Harvesting
To identify the qualified transactions, you must track when you bought and sold each NFT, the price you paid and received, and any fees involved. You also need to know whether you made a short-term or long-term gain or loss because these are taxed differently.
What Proportion of My Losses Should I Harvest?
It depends. If you have a lot of gains to offset, you may want to harvest as much as possible. Harvesting these losses can help reduce your tax burden and maximize your savings. On the other hand, if you don't have many gains to offset, you may want to harvest less to save some losses for future tax years. Remember, you can offset all your capital gains and up to $3,000 per year of ordinary income.
How Exactly Do I Tax Loss Harvest NFTs?
Harvesting your NFT tax losses is done easily with a crypto tax platform. Accointing by Glassnode helps you to benefit from this strategy in a few simple steps.
- Determine your current capital gains for the tax year: To understand your tax situation, you need to know your current capital gains for the year. Our platform can help by analyzing your portfolio and providing an overview of your gains.
- Identify NFTs that have decreased in value: To harvest your unrealized losses, you need to know which NFTs have decreased in value. While our platform can't provide the current value of your NFTs, we can help you determine their cost basis. The cost basis and current value are needed to identify potential losses.
- Sell the NFT to realize the losses: To harvest losses, you must sell the NFT. While our platform can't help you with the sale, we can help you determine how many NFTs to sell by showing your current capital gains.