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Cryptocurrency, or digital currency, has skyrocketed in popularity in recent years. More people are investing in digital assets like Bitcoin, Ethereum, and Dogecoin due to their increased accessibility. Non-Fungible Tokens (NFTs) have also made huge waves in the investment world as a similarly appealing alternative to the stock market. However, like any investment, there are many tax considerations to take into account as the IRS increases resources to collect on them.
What Are Cryptocurrency and NFTs?
If you’re new to the scene, cryptocurrency and NFTs can come across as confusing and hyper-technical replacements for securities, but their cultural impact is being felt across the world. In plain terms, cryptocurrency is a type of digital asset that is designed to work as a medium of exchange, like any other currency. It’s appealing to many because they’re decentralized, without any central authority like the government or banks.
NFTs are unique digital assets, usually created by digital artists, representing ownership of that digital content – like artwork, music, or videos. They’re not interchangeable – hence “non-fungible”– and are completely unique due to the complex algorithms designed for them. In a way, the NFT industry has a lot in common with the fine art industry. Additionally, you could technically purchase an NFT using cryptocurrency.
Impact on Taxes
Tax laws surrounding cryptocurrencies and NFTs constantly change as the IRS levels up their understanding. As a result, it’s likely that those who buy and sell cryptocurrencies and NFTs are more likely to face an audit. The IRS views cryptocurrency as property rather than traditional currency. Gains and losses from their sale or exchange are subject to capital gains tax just like stocks, bonds, and other securities.
It’s important to note that the IRS has been cracking down on the taxation of securities in recent years. There seems to be more suspicion around owning cryptocurrency and NFTs due to the fact that they’re still incredibly new and convenient to buy, trade, and sell in an unregulated market. Although the IRS has issued guidance on how to do your taxes as a digital asset enthusiast, they may be more likely to audit taxpayers because it’s so difficult to track and verify income and losses.
Avoiding Criminal Charges
Although you may not be able to completely avoid an audit, creating a “paper trail” by maintaining thorough records. Performing due diligence like keeping track of all transactions, including dates, amounts, and valuation at the time of sale or purchase, will be extremely important if the IRS comes knocking on your door. Records that show the cost basis of cryptocurrency holdings and NFTs will help you and your CPA correctly file tax returns. With a high number of transactions, it’s possible to miss a few, but too many, and basic negligence could quickly look like income was intentionally concealed.
Cryptocurrency and trading NFTs can be an amazing investment and a great way to diversify your portfolio, but it’s essential to keep up with regulations and tax compliance to avoid unnecessary fines or criminal charges. With the IRS becoming more vigilant about auditing and enforcement, it’s important to have experienced tax attorneys on your side. If you are in need of legal guidance regarding your tax obligations or are facing an audit, reach out to our office by calling (305) 374-5544 for a consultation.
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