NFT Tax Loss Harvesting in 2023
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NFT tax loss harvesting is the practice of strategically selling assets at a loss in order to offset your capital gains. We’re written extensively about the topic before, but have largely focused on tax loss harvesting for fungible tokens, such as Bitcoin or Ethereum.
Some NFTs are illiquid and can be difficult to sell. Benefit from alternative solutions including donating your NFTs or using NFT harvesting tools.
Offset a portion of regular income by using your losses or carrying losses over to a different tax year are both options for getting the most out of your unprofitable trades.
NFT tax loss harvesting
Finding the best opportunities for NFT tax loss harvesting is more difficult. Because each NFT is unique, there isn’t a known fair market value for each one. This makes it hard to pinpoint which NFTs would realize the largest losses.
However, services and software are emerging to tackle the problem. For NFT fine art, professional third-party appraisals are provided by a growing number of art appraisers who are familiar with the crypto asset class.
Meanwhile, automated solutions are popping up for popular NFT collections like Bored Ape Yacht Club, CryptoKitties, or NBA TopShots. These use blockchain data to track the sale prices of NFTs, so price predictions are up-to-date with market conditions. While each service’s methodology is unique, most analyze factors including:
Sale prices: Naturally, an NFT’s past sales prices, especially recent sales prices, will play a large role in predicting what it could currently fetch on the market .
Floor price: This refers to the lowest listed price of an NFT in the same collection
Rarity: NFTs that are part of a collection typically have traits of certain categories, some of which are rarer than others. The rarer an NFT’s combination of traits are, the higher it will be valued.
Best NFT tax loss harvesting tools
Several companies have emerged to capitalize on the NFT market to support crypto traders to harvest NFT losses and reduce their crypto taxes:
The NFT Loss Harvestooor: Best for Ethereum-based NFTs
Unsellable NFTs: Best for high-volume traders
Alternative: TokenTax crypto tax software
Realizing a loss on an NFT
To use losses to offset crypto gains, you need to realize the loss by selling, swapping, or otherwise disposing of the asset. Between NFT rug pulls and failed projects, it’s not uncommon for an investor to hold assets that can’t easily be sold. So, what can traders do?
Your goal should be to trade the asset in an arm’s length transaction. This means that each party acts independently in their own self-interest, without pressure from the other party.
For example, selling an NFT on OpenSea for 0.01 ETH to someone you don’t know would be considered an arm’s length transaction.
Donating NFTs for tax deductions
Another way to get tax savings is to donate to a 501(c)(3) organization. An NFT donation realizes a loss or gain, and the fair market value of the asset can be deducted if you are itemizing deductions (up to 30% or 50% of your income, depending on the type of organization you’re donating to).
NFT donation example
If you bought an NFT artwork for $30,000 of ETH and then donated it to a museum when the digital asset was valued at $100,000, you would not only not be taxed on the $70,000 gain, but you could also deduct the fair market value of the NFT ($100,000) if you reported itemized deductions, provided you had the necessary documentation and the sum didn’t exceed the income threshold.
However, be aware of three requirements if you plan to reduce your crypto taxes by deducting NFT donations:
If you donate a short-term asset, you may only deduct the NFT’s cost basis. In this example, that would be $30,000.
The IRS requires documentation of your donation and the amount of required documentation increases as the worth of your donation increases. If the asset’s fair market value exceeds $5,000, you will need a qualified appraisal of the NFT, which can be difficult to find.
You must donate the NFT directly to the 501(c)(3) organization to defer tax on the $70,000 gain. If you sell an NFT and donate the proceeds to the organization, you are still liable for capital gains taxes on the sale of the NFT, though you would still be eligible for a $100,000 itemized deduction.
How TokenTax helps with NFT tax loss harvesting
If you’re using crypto tax software, it’s relatively simple to identify opportunities for fungible crypto tax loss harvesting.
For example, TokenTax provides a tax loss harvesting dashboard that displays the assets you’re holding at a loss, as well as the amount of the loss.
Software accomplishes this by pulling in exchange data, updating coins’ fair market values in real time and subtracting from them their cost basis so traders can gauge how large their loss would be.
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NFT tax loss harvesting FAQs
Here are answers to frequently asked questions about NFT tax loss harvesting.
Can I sell an NFT to myself to realize a loss?
No. Once again, for an arm’s length transaction to occur, there needs to be two parties acting independently. “Selling” an asset to yourself does not fulfill these criteria.
Can I sell an NFT to my friend to realize a loss?
If the only reason your friend is purchasing a worthless NFT from you is so that you can claim the loss on your taxes, you are not completing an arm’s length transaction; your friend is not acting independently of your wishes. We do not recommend this strategy for NFT tax loss harvesting.
Can I claim my worthless NFT as a casualty or theft loss?
The Tax Cuts and Jobs Act of 2017 eliminated casualty and theft loss deductions in all cases except federally-recognized disasters. NFT rug pulls, scams, or failed projects do not meet this criteria, so no, you cannot claim worthless NFTs as a casualty or theft loss.
Can you deduct losses from NFTs?
Yes, you can typically deduct losses from NFTs for tax purposes. NFT tax loss harvesting involves strategically selling NFT assets at a loss to offset capital gains. This practice can be especially helpful in crypto when certain NFTs are illiquid and a challenge to sell.
Does burning an NFT count as a tax loss?
The IRS has not provided guidance suggesting that transferring a token to a burn address results in a realized loss, so we do not recommend this approach. We recommend exploring legitimate methods such as selling, swapping, or donating NFTs to manage losses for tax purposes. Transparent and arms-length transactions are crucial for compliance, ensuring that both parties act independently and in their own self-interest.
Can I tax harvest crypto losses?
Yes, US taxpayers can engage in tax harvesting of crypto losses. Tax loss harvesting involves realizing investment losses to offset capital gains and reduce taxable income. In the context of cryptocurrencies, including NFTs, traders can strategically sell assets at a loss to counterbalance gains. This practice is particularly useful in the volatile crypto market, where assets may fluctuate significantly in value. Investors may be able to optimize their overall tax liability by carefully managing losses.
Can I get money back from crypto losses?
While you can't directly get money back from crypto losses, you may be able to use losses to offset taxable gains and potentially reduce your overall tax liability. The process involves realizing losses on crypto investments, such as NFTs, and using those losses to offset capital gains. When in doubt, consult a crypto tax professional for guidance and to plan an effective and legal crypto tax strategy.
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