While the declining hype around NFT trading has been a concern for investors, it may act as a silver lining for tax saving.
Losses incurred by you can be claimed to offset your capital gains and reduce your overall tax bill. And this can be done through NFT tax loss harvesting. In this article, we discuss everything you need to know about harvesting your NFT losses and how you can leverage it to reduce your tax burden.
What Is NFT Tax Loss Harvesting?
NFT tax loss harvesting is the practice of selling a non-fungible token (NFT) at a loss to offset crypto taxes on other capital gains. The idea is to sell the NFT at a lower price than what was paid for it, and then use the loss to offset capital gains from the sale of other assets.
This strategy helps to reduce your overall tax burden and potentially increase your after-tax return on investment. To know in-depth about tax loss harvesting for all your crypto assets, you can refer to our crypto tax loss harvesting guide.
You can claim your capital losses to offset up to $3,000 of income for the given tax year. Any additional losses can be taken forward into future years to offset gains.
Step-By-Step Guide For NFT Tax Loss Harvesting
To give you a better picture of how to use your NFTs for tax loss harvesting, we have broken down the entire process into three steps:
- Determining which NFTs can be sold for tax loss harvesting purposes
- How to realize losses by disposing of your NFTs
- How you shouldn’t dispose of your NFTs to realize losses
Let’s look at each of the steps in detail.
How To Determine Which NFTs Can Be Used To Realize Losses?
Tax loss harvesting requires you to identify NFTs that can be disposed of to realize losses. To do this, you first need to look into the fair market value of your NFTs at the time of selling.
However, this process can become challenging as every NFT is unique with variable market values. Automated software like Kryptoskatt can simplify this by helping you identify tax loss harvesting opportunities for your assets.
Once you find their fair market value, you can then subtract it from the cost basis of your NFT to determine whether or not they can be sold to realize losses.
How To Dispose Of Your NFTs To Realize Losses?
Once you have decided which NFTs can be used to offset your capital gains, it is time to dispose of them to realize losses. While there are many methods to do so, the best way to tax loss harvest your NFTs is to sell them to someone else at a loss.
But because the NFT market is hype-driven, it often becomes difficult to sell your NFTs if the craze is gone. In this case, there may not be any purchaser to actually buy your NFTs and you will not be able to realize a loss.
Another way to dispose of your NFT for tax deductions is to donate them. These transactions are exempted from taxes for both the donor and the receiver if you fulfill these three criteria:
- You have held the NFT for more than a year
- You are donating it directly to the concerned organization
- The receiver falls under the tax-exemption category by IRS
It is important to note that the disposal of NFTs must be a ‘arm's length transaction’ to reap tax benefits. This means that both parties concerned with the transaction of the NFT asset should be independent of each other, acting solely in their self-interest, and shouldn’t be influenced by the other.
When Should You Not Tax Loss Harvest Your NFTs?
While we discussed the right way to dispose of your NFTs, here are three scenarios where you shouldn’t use your NFTs for tax deductions.
1- Selling NFT To Your Friend For Tax Loss Harvesting
As discussed earlier, you must sell your NFTs in arm's length transactions to gain tax benefits. If you sell an NFT to your family or friends, it may become hard to prove that the two parties are acting independently, especially if you use the realized loss to offset capital gains. Hence, we recommend avoiding this method of tax loss harvesting your NFT.
2- Selling NFT To Yourself For Tax Benefits
In this case, you do not fulfill the arm’s length transaction requirement of two independent parties involved in the NFT disposal and it will not be considered for tax benefits.
3- Burning NFT For Realizing Losses
Burning your NFT simply means you are sending it to a dead wallet address that no one can access. While the NFT still remains in the blockchain, it is removed from circulation. The IRS does not have any clear guidelines for this type of transaction and tax loss harvesting through this method must be avoided as of now.
Harvest NFT Losses With Kryptoskatt
NFT tax loss harvesting is a great way to offset your capital gains and improve after-tax return. However, unlike other assets, NFT transaction guidelines can be complex. While harvesting your losses manually can be considered, it may lead to missed tax-saving opportunities and higher tax bills.
Kryptoskatt helps you calculate your realized and unrealized losses and gains so that you can maximize your tax savings. To do this, all you need is to auto-sync your transactions and let the platform do the rest for you. Sign up today to try Kryptoskatt for free.
Can I burn an NFT to realize a loss?
-The IRS does not have any clear guidelines for this type of transaction at present and so this method must be avoided if you want to realize a loss by disposing of your NFT.
Can I sell an NFT to myself to realize a loss?
-You must sell your NFTs in arm's length transactions to gain tax benefits. Selling NFT to yourself doesn’t fulfill the requirement of two independent parties involved in the NFT disposal and it will not be considered for tax benefits.
Can I sell an NFT to my friend to realize a loss?
-If you sell an NFT to your friends or family, it may become hard to prove that the two parties are acting independently, especially if you want to realize a loss. So, we suggest you do not use this method.
Can I claim my worthless NFT as a casualty or theft loss?
-No, you cannot claim your worthless NFTs as a casualty or theft loss as the ‘Tax Cuts and Jobs Act of 2017’ has removed both of these types of cases from tax exemption.