I hate to be the bearer of bearish news, but preparing your (or your clients’) crypto tax returns just got trickier. Remember that curious little box on the 1040 tax form asking whether or not you (or your client) bought or sold “virtual currency” during the year? Well, that little box just got an upgrade.
The IRS released an updated draft for its 2022 instructions for form 1040 that replaces the “virtual currency” classification with that of a broader category of “digital assets,” including explicit recognition of NFTs.
The draft instructions state that “digital assets are any digital representations of value that are recorded on a cryptographically secured distributed ledger or any similar technology. For example, digital assets include non-fungible tokens (NFT) and virtual currencies, such as cryptocurrencies and stablecoins.”
Put on your leotard because finding a silver lining in anything the IRS does requires serious mental gymnastics.
Typically, the IRS is very slow in publishing guidance like this, so at least they’re moving in a direction, even if it’s not necessarily the right one. So now, instead of pretending like you know how NFTs are taxed, we have somewhat clear rules. Surprisingly, the new instructions even account for the receipt of digital assets as a result of mining, staking, and hard forks. Crypto tax friends, I know what you are thinking:
I am not sure if this is good or bad news, but the IRS opted not to classify NFTs as collectibles. That would have made sense to me, considering that art, stamps & coins, cards & comics, rare items, antiques, and so on are collectibles for tax purposes. NFTs are basically just digitally verifiable versions of those things.
This might be good news because collectibles are generally taxed at a 28% rate, whereas stocks, bonds, and crypto are taxed at 0, 15, or 20%, depending on sellers’ income.
First and foremost, NFTs clearly aren’t stablecoins (if you don’t believe me, I’ll show you my NFT portfolio; it makes even Terra look stable), so why are we throwing them all in the same category? That is like classifying Die Hard as a Christmas movie or a pickle as a fruit (technically true, but practically false). What is worse is the IRS sneakily worded the document to allow for the taxation of any new digital asset class in the future. The agency said if “a particular asset has the characteristics of a digital asset, it will be treated as a digital asset for federal income tax purposes.”
The problem with haphazardly clumping all digital assets into a single broad category and tax treatment is that these assets are unique. I suppose we are partially to blame since we tend to clump every product of blockchain technology into “crypto” or “web3.” This scenario plays out in one of two ways: 1) tax guidance becomes a moving target that changes each time we begin to understand it, or 2) we nonsensically apply uniform tax guidance across a broad spectrum of assets.
Think about it. Does it really make sense to group these assets in with cryptocurrencies and stablecoins?
I think the IRS had one goal in mind when they updated the language around digital assets: rake in more tax revenue while making their jobs easier.
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