Reduce Your Taxes Using Worthless NFTs: A Powerful Tax-Saving Strategy
Posted On June 12, 2023
There are many people who bought stupidly expensive NFTs with no real utility that are now virtually worthless. If you, too, made the mistake of getting caught up in the hype and FOMO and now don’t know what to do with them, we might have a solution for you – reduce your taxes using worthless NFTs.
NFTs have been around since 2014, but they really took off in 2020, and in 2021, they exploded into the mainstream. Artists made millions of dollars selling art on NFT marketplaces. For instance, the famous Everdays – the first 5000 days by Beeple sold for $69 million. Some people made millions flipping NFTs.
Even non-art tokens were sold for huge sums, like Jack Dorsey’s first tweet, which sold for $2.9 million as an NFT. This was the new trend, and everyone was hopping on it. Investors, celebrities, influencers, ordinary people, everyone was capitalizing on it.
Come 2022, inflation rose, interest rates got hiked, and NFTs quickly faded away, especially the ones that thrived solely on the hype with no underlying value or utility. NFTs that sold for millions, like Jack Dorsey’s tweet, is now struggling to get bid higher than $132 in auctions.
While it’s not possible to turn back time to undo your purchases, the best you can do is to utilize these worthless NFTs to reduce your tax bill, and that is what we’ll talk about in this guide.
How are NFTs Taxed?
NFTs, or Non-fungible tokens, are unique digital assets belonging to only one owner at any given point in time.
While it’s as easy as taking a screenshot to make clones of digital files, NFTs come with a digital certificate of ownership. These ownership records are stored on the blockchain, making them inalterable and unique. We explain how NFTs work and the technology behind them in-depth here.
Mostly, NFTs are used by artists to tokenize their art and sell to a wider and more accessible audience, while traditionally, it was a very niche practice reserved for hobbyists, collectors and rich people. However, its use is not only limited to art. Eventually, NFTs can and are tokenizing everything, including tickets, subscriptions, documentation, ownership, etc.
As for taxes, NFTs are treated the same as cryptocurrency – digital assets, which means, in most countries, it’s viewed as property. Therefore, NFTs are subject to the same tax implications as cryptocurrencies – capital gains taxes.
To find out how NFTs are taxed in your country, just find out how crypto is taxed in your country and then apply the same rules to NFTs. Check out our crypto tax guides for different countries.
For example, in the US, crypto is treated as property. So, selling, swapping or disposing of crypto will attract capital gains taxes. Therefore, selling, swapping or disposing of NFTs will also attract capital gains taxes. Some may argue that NFTs should be considered ‘collectibles’, but as far as the stance of the IRS goes, they treat NFTs the same as crypto. And that is the same for almost all countries.
On a side note, if you’re an NFT artist or creator, selling your artwork will subject you to income taxes (in most countries).
Reduce your Taxes Using Worthless NFTs
Using worthless NFTs to reduce your tax bill is nothing but a form of tax-loss harvesting. Just to quickly recap, tax loss harvesting is a strategy where taxpayers sell non-performing assets, like cryptocurrencies, to incur losses that they then use to offset gains and reduce taxes.
You can do the same with NFTs. However, tax-loss harvesting using NFTs is a little different and probably complicated. Here are the steps to successfully reduce taxes using worthless NFTs.
Identify NFTs Sitting at a Loss
With cryptocurrencies, you can see when a coin is sitting at a loss as there is a price that the coin is worth that the entire market agrees upon, called the fair market value. However, with NFTs, it’s slightly different.
Since NFTs are more like collectibles and art pieces, they don’t have a standard fair market value. So, identifying which NFTs are sitting at a loss and how much loss becomes challenging.
However, there are platforms that help you estimate the prices of popular NFT collections, like DeepNFTValue and NFT Valuations. These estimates are based on factors like sale prices, floor prices, and the rarity of the NFT.
You can do this manually yourself too. For instance, you can compare the current floor price of an NFT collection to its all-time high and see if there is a significant difference. If it is, it might indicate that its demand is starting to or already has declined. Also, the wider the bid/ask price for the collection is, the more illiquid the market is, which might be another negative indicator.
Based on these factors, you can identify the NFTs in your portfolio that are sitting at a significant loss.
Sell or Dispose of it
The first place you should go to sell your NFTs is an NFT marketplace, even if you get virtually nothing. However, it’s quite possible that no one wants to buy the worthless NFTs you’re trying to sell, and realistically, why would they?
Peer-to-peer transactions are not recommended as they might not fit the arm’s length transaction criteria (devised to avoid people exchanging NFTs with friends and family for tax benefits).
So, what do you do?
There is one way out of this – burn wallets.
Burn wallets allow you to send your cryptocurrencies or NFTs to a wallet, where they will be effectively “burned” and removed from the supply.
Burn wallets are not new in the crypto space, but their use in NFTs is, due to the number of people trying to get rid of their worthless NFTs. Unsellable NFTs is one such wallet. It allows you to sell NFTs for about 0.08 ETH + gas.
However, it’s not clear if tax authorities approve of this method as a legit way of disposing of your digital assets. Hence, it’s better to consult a tax professional.
Lastly, you can gift NFTs. This option is only available to people in countries where gifting cryptocurrencies and NFTs is seen as a disposable event. More on this later.
Once you’ve sold or disposed of your NFTs and incurred the losses, you can report them in your next tax report and use them to offset them against your capital gains.
Reduce your Taxes While Still Keeping Your NFTs
Even though your NFTs are worthless now, you might still not want to sell them for various reasons. Perhaps you still think they hold a promise. Maybe you like them. Or maybe you just don’t want to.
So, what if there is a way to reduce taxes using your worthless NFTs while still keeping them?
There are a couple of methods to do exactly that.
Gift your NFTs
As we mentioned earlier, if you live in a country where gifting cryptocurrencies, and by extension also NFTs, is seen as a disposal event, you can gift them to your spouse or someone within the family to incur losses, but at the same time, keep the NFTs within the family.
The same goes for crypto too. Many people gift crypto as a tax-saving strategy.
The following are countries where gifting crypto is seen as a disposal event. You can know more about their tax laws around crypto by clicking on them.
The Wash Sale Rule
As you might have noticed, the US is not among the countries that view gifting crypto as a disposal event. While that is not a bad thing in itself, as that has its own tax-saving opportunities, the US crypto tax laws do have a tax loophole that you can utilize to reduce taxes using your worthless NFTs while still keeping your ownership, at least, on theory.
Enter the wash sale rule. We have an in-depth guide about the wash sale rule and how you can utilize them to save taxes and keep your crypto. But to quickly recap – it’s a rule that prevents you from claiming losses on the assets you repurchase within 30 days before or after selling them.
While this law applies to stocks and securities in the US, it does not apply to crypto and, by extension, NFTs. So, you could just sell your NFTs, claim the losses and buy them right back. It’s basically tax-loss harvesting with an additional step. It allows you to reduce taxes using your worthless NFTs while still keeping its ownership.
The only problem you’ll run into is when buying it back. As we discussed, selling or disposing of NFTs is trickier than selling cryptocurrencies.
You can’t buy back the NFTs if you send them to a burn wallet unless the creator has multiple copies of the same NFT in their collection available for sale.
The only two possible ways are – a) if you can somehow buy it back in an NFT marketplace or b) if you can figure out a way to do a peer-to-peer transaction while still qualifying for tax write-offs.
However, it can get super complex and risky real quick. So, we suggest you consult a tax professional.
How Much NFT Losses Can One Offset?
As much as your country’s tax laws allow you to offset.
Some countries, like the US, the UK and Australia, have no limits on how much you can offset against your capital gains.
In fact, in the US, if you have gains to offset your losses against, you can deduct up to $3000 from your ordinary income in a financial year. You can also carry forward any unutilized losses to future years. You can read our in-depth guide on crypto taxes in the US to know more.
Although it’s a little tricky and complicated to reduce your taxes using worthless NFTs compared to cryptocurrencies, it’s still worth it, especially when you’re trying to survive a crypto winter like the current one.
Plus, you don’t necessarily have anything better to do with them anyway, so why not sell them and save more taxes?