Crypto and NFT Taxes | What Do I Need to Know Before 2023?
Another wild year is coming to a close. While there is a lot of uncertainty around some recent events, one thing remains certain (or three things if you’re going to hodl us to it) - life, death, and taxes. We've brought back our friends at RKO Tax to help clarify some of the points raised in last year’s tax roundup and also provide some insight on what to look out for in the near future.
RKO has grown a lot since starting up last year and remains committed to helping the crypto-native community navigate the difficulties of tax planning and preparation. Active participants in crypto themselves, RKO works with some of the most well-respected NFT artists and degens alike.
Whether you need help with reconciling your crypto transactions or need to ask a question like what a 1099 is, RKO is your source. If you are interested in learning more about RKO, please feel free to reach out to Allie, Sean, or RKO.
Most of the basics from the RKO run-down from last year will remain the same but keep reading for some insight on what has changed, what may likely change, and what you should be doing about it.
1. Understand the Assets You Hold
Maybe you only hold Ethereum, Bitcoin, or Solana. Maybe you were involved in some degenerate yield-farming or maybe you hold some NFTs. Regardless, it is important to understand how the assets you are transacting with are treated from a tax perspective and what the ramifications of transacting with those assets could be.
Cryptocurrency (ETH, BTC, SOL, etc.):
Tax treatment: Capital assets
Tax rate(s):
- Short-term holding (<1 year): ordinary tax rates*
- Long-term holding (>1 year): preferential tax rates (0%, 15%, 20%)**
Yield Farming:
Tax treatment: Ordinary income upon the claim, capital gain upon sale
Tax rate(s): ordinary tax rates* upon the claim, capital asset classification (above) upon sale
NFT:
The IRS recently announced that it will retire the phrase “Virtual Currency” in the tax code and replace it with “Digital Assets” in order to encompass more assets (i.e. NFTs) in their cryptocurrency tax legislation and guidance. This means that the IRS has formally committed to classifying NFTs in the same manner as other cryptocurrency assets, solidifying their tax treatment as capital assets and not collectibles. Assets in this category will be taxed at long-term or short-term capital gains rates, not the flat rate of 28% that applies to collectibles.
Tax rate(s):
- Short-term holding (<1 year): ordinary tax rates*
- Long-term holding (>1 year): preferential tax rates (0%, 15%, 20%)**
Airdrops/Token Drops:
As there are a variety of methods and processes used for airdrops/token distributions, there is no simple answer to airdrop treatment, and each should be reviewed on a case-by-case basis. The biggest factor in determining the timing of income recognition from an airdrop is a constructive receipt. In other words, whenever you have dominion and control over the asset, you will owe tax on the value at this time.
Tax treatment: Ordinary income upon the claim, capital gain upon sale
Tax rate(s): ordinary tax rates* upon the claim, capital asset classification (above) upon sale
2. Take This Opportunity to Harvest Some Losses to Offset Any Taxable Gains Before the Year Closes.
If you have capital gains that you realized in 2022 (I know, maybe not most of us!), you can take this opportunity to harvest some losses to offset those gains. In the tax world, your overall short-term or long-term capital gain position is calculated by netting gains and losses to come up with an overall gain or loss position. This means that if you are currently sitting in a gain position, you may have the opportunity to sell some assets for a loss to help offset some gains.
It is worth noting that the maximum total capital loss you can take in a given year is $3,000. If your losses exceed $3,000, any excess is carried over to future years to offset the gains recognized in that year.
Example
Emma has $10,000 in long-term capital gains in 2021. At the same time, however, she has $20,000 in capital losses. Her net capital gain/loss on his 2021 return would have been -$3,000 with the residual $7,000 carried forward.
In 2022, Emma has $45,000 in recognized gains and no losses! She currently stands with a $38,000 gain on her tax return since she can use up the loss carry-forward of $7,000 from 2021. If she has some assets in an unrealized loss position, she could sell some if she wants to lower her taxable gain for 2022 even more.
3. Take Advantage of the Wash-Sale Rules
Please note that this was on some dockets to change in early 2022 and there is currently no update on when or if this will be put into place. It is unlikely for the IRS to implement this change retroactively (meaning if they implemented it to apply to the previous year or months leading up to the change) but it's worth noting that this could change.
If you hold any assets that have depreciated in value over the course of the year but you want to hold long-term, there is an opportunity for you to sell the asset for a loss before the end of the year to soak up some losses to offset your capital gains. Once the asset is sold, you can re-purchase the asset to reclaim your position. However, it is important to allow at least some time to pass between the two transactions in order to expose yourself to some economic risk to substantiate the trade. There is no set rule on how long you should wait, but the point is to allow for some market fluctuation.
In the traditional finance world, this would be known as a wash-sale if the transactions (sale & repurchase of the same asset) occurred within 30 days of each other. These rules do not apply to crypto (yet!), so you may want to take advantage of this before it goes away.
It is important to note that the repurchase will set your cost basis on the new asset and could potentially result in a higher gain if sold in future years.
Example
Alex purchased 100 of Coin 1 in 2018 for $150/coin. In 2022, the coin has plummeted to $50 but Alex believes it will bounce back in future years.
Alex sells all 100 shares of Coin 1 on August 1st, 2022 at a price of $50/coin. Alex has a loss of $100/coin, or $10,000 ([$50 - 150] * 100 = $-10,000).
Alex then repurchases 100 shares of Coin 1 at $50 on August 2nd, 2022. Alex’s new basis in Coin 1 is $50. This means if the price of Coin 1 skyrockets to $500 in 2025 and Alex liquidates his position, he will have a long-term capital gain of $450/coin, or $45,000 ([$500-50]*100 = $45,000).
Alex can use the $10,000 loss he realized in 2022 to offset his 2022 gains on his tax return.
4. Tax Plan for Updated Tax Brackets in 2023 ***
The 2023 Federal tax rates have been adjusted to account for inflation. The highest income tax rate of 37% is now reached at an income of $578,125 instead of $539,9000 for 2022. If you fall into this tax rate, not much is changing for you in 2023 other than you will have slightly less income taxed at the highest marginal tax rate than you did in 2022.
If your income level falls in one of the lower tax bands, however, 2022 provides an opportunity for tax planning around expected income in 2023 and your anticipated tax rates. If you expect to fall into a higher tax rate next year due to a new project or maybe you got a raise at your job, it may be worth selling some assets to lock in the tax at your 2022 rates as opposed to your 2023 tax rates.
This will likely only be applicable if you were considering selling something regardless of the timing between 2022 & 2023, but because capital gains are taxed at essentially your highest marginal rate (tax is calculated after employment income), you may see some significant tax savings by selling in 2022 as opposed to 2023.
Example
If you make $150,000 at your job in 2021, you will fall into the 24% tax bracket (as a single filer). This means that any $ earned on top of your salary of $150,000 will be taxed at 24% until your income surpasses $164,925, at which point it will be taxed at 32%.
At this rate, if you are thinking about selling an asset worth $10,000, it will be taxed at 24%.
If you got a raise and your anticipated salary for 2022 is $200,000, you will fall into the 32% tax bracket and any additional dollar earned on top of your salary of $200,000 will be taxed at 32% until your income surpasses $215,950, at which point it will be taxed at 35%.
With the 2022 rates and salary adjustment, that same asset that you wanted to sell for $10,000 would be taxed at 32% instead of 24% like in 2021.
On the contrary, if you are expecting your income to remain at the same level in 2023 as it was in 2022, on paper, you should see tax savings built into the adjusted rates.
2022 Federal Tax Rates (single filer):
2023 Federal Tax Rates (single filer):
5. Prepare for Your Tax Liability (i.e. Transfer Some Crypto to Fiat to Prepare for Your Estimated Tax Bill)
This one is obvious, but it is also a double-edged sword. If you need to sell assets to pay for your tax bill, there are built-in tax implications (as mentioned above). The easiest way around this is to harvest some losses with coins that have gone down in value or sell some assets (NFTs) that have underperformed. You will have some extra capital to cover your tax liability, and you will also harvest some losses to offset some of your (hopefully) gains.
In addition to your federal income tax liability, keep in mind you will likely have a Net Investment Income Tax (NIIT) tacked on to your federal tax liability in addition to your state tax liability. The NIIT is a flat 3.8% assessed on investment income like capital gains (including NFTs) at the federal level.****
6. Start Closing Out 2022 and Preparing for 2023
Now that 2022 is coming to a close, it is a good time to start locking down an accountant (if you do not already have one) and start thinking about the fourth quarter estimate for 2022. If you make quarterly payments, the last one for 2022(2022 Q4) is due on January 17th, 2023.
If you aren't sure if you should be making estimated payments, the general rule of thumb is: your total withholdings and estimated tax payments need to equal 100% of your prior year tax liability (110% if your adjusted gross income is over $150,000 or $75,000 if you are married and filing a separate return from your spouse) or 90% of the current year tax liability.
If you aren’t sure if you should be making an estimated tax payment, talk to your accountant.
Check your year-to-date withholding and payments to see if it conforms to 90% of the current year or 100% (or 110%) of the prior year tax liability rule. This will be important to keep in mind over the course of 2022 as the payments are due at the following cadence:
Q1: April 15th
Q2: June 15th
Q3: September 15th
Q4: January 15th
If the final liability on your tax return exceeds the amount you paid through withholdings or estimated tax payments, the amount due needs to be paid by the original due date of your tax return (April 18, 2023) to avoid incurring a late payment penalty.
7. Buckle Up.
Obviously, bear markets are never fun but this one is ruthless. If you were affected by any of the recent exchange collapses, don’t lose all hope. There will be an opportunity in the bankruptcy proceedings to claim back some of the assets lost within the platforms, but not all. Unfortunately, due to the tax law changes in the TCJA, for tax years 2018 through 2025, taxpayers are only allowed to deduct casualty and theft losses related to homes, household items, and/or vehicles if the loss is caused by a federally declared disaster.
Unfortunately, theft losses like hacked crypto wallets or scams and casualty losses like sending your crypto to the wrong wallet are likely no longer deductible on the federal tax return until 2026 when the TCJA provisions expire. Taxpayers who experience these kinds of loss of their crypto should discuss their situation with their tax accountant and/or lawyer before recording the loss of cryptocurrency as a sale when reconciling their transactions for income tax purposes.
Along with the CEX funerals we had this year, the US government will be placing more scrutiny on crypto than ever. It has always been important to report everything and be honest, but likely now more than ever. Over the past year, the IRS has issued a series of John Doe summons to some of the major exchanges requesting user information such as income earned, crypto traded, and user data.
If you have any questions about any of the information in this article, please reach out to your accountant or RKO Tax on Twitter.
*Ordinary Tax Rates
**Preferential long-term capital gains rates:
*** 2022 Tax Rates:
****Net Investment Income Tax:
Income filing charts courtesy of NerdWallet.com
