NFTs, or non-fungible tokens, became explosively popular in 2021 with the launch of Bored Apes, Cyber Punks, and other prominent collections. Celebrities like Logan Paul brought up millions of dollars worth of collectibles.
But fast-forward a couple of years, and it’s a buyer’s market. For example, Logan Paul’s NFT collection, which he spent more than $2.7 million to build, is worth just over $1 million today.
If you’re in the same boat, you may consider realizing some of those losses to offset other capital gains or ordinary income using a popular tax-saving technique known as “tax loss harvesting.”
Let’s explore tax loss harvesting and how you leverage worthless NFTs to reduce your year-end taxes.
What is Tax Loss Harvesting?
Do you have an NFT you purchased for more than it’s worth now?
Well, just like you don’t pay capital gains taxes until you sell a stock at a profit, you can’t “write off” a loss until you press the sell button.
Tax loss harvesting involves selling an asset to realize a loss and offset other capital gains or ordinary income. With fungible cryptocurrencies, like Bitcoin or Ethereum, you can repurchase the exact asset after 30 days (to avoid the Wash Sale Rule). But, of course, repurchasing the same NFT after 30 days isn’t as easy or practical.
Here’s how it works:
- You have a great year and have $10,000 in short-term crypto profits.
- You have an NFT you purchased a few years ago for $5,000 that’s worthless today.
- You sell your NFT for $0 and realize the $5,000 loss.
- The $5,000 realized loss results in $5,000 in net profits for the year.
- Assuming you’re in the 20% tax bracket, you saved $1,000 (20% x $5,000).
The first “gotcha!” is the Wash Sale Rule.
The IRS rule says you cannot sell an asset to realize the loss and immediately repurchase the same asset. Their rationale is that there was no actual change in your “economic situation” if you own the same asset, and therefore, the loss isn’t eligible to be used as a “write-off” on your taxes.
The second “gotcha!” is the idea of an Arm’s Length Transaction.
Suppose you and a friend both have worthless NFTs—you might feel the temptation to swap NFTs to realize the losses since you’re both technically disposing of them. However, the IRS doesn’t allow you to write off these losses since you and your friend are “influencing” each other. In other words, the transaction isn’t an “economic decision.”
So, to recap, you have to sell an NFT to realize a loss for tax purposes, but you cannot repurchase the same NFT within 30 days and you can’t just sell it to a friend.
How to Harvest NFT Tax Losses
The tax loss harvesting process is straightforward—you simply sell the NFT, and the difference between the purchase price and the sale price is your realized loss.
The problem is that NFTs aren’t as easy to sell as fungible cryptocurrencies. While it’s easy to sell Bitcoin, selling a piece of NFT art means finding the right buyer—or any buyer. Some NFTs are completely illiquid, meaning nobody may be interested in purchasing it..
If your NFT is still worth some money, you can list it on an NFT marketplace, like OpenSea, and try to sell it at a loss. However, you should avoid peer-to-peer transactions because the IRS may not consider it an “arm’s length” transaction.
NFT Tax Loss Harvesting Tools
NFT tax loss harvesting tools can help solve these challenges by providing a “buyer of last resort” for your worthless or low-value NFTs.
Unsellable NFTs are the most popular platform for realizing NFT losses. While they charge a fee of 0.001 ETH for each NFT you sell, the platform lets you unload up to 1,000 NFTs at once, making it the platform of choice for those with extensive collections. They also provide a tax receipt that you can use to verify the transaction if the IRS expresses any concerns.
If you only have a few NFTs, you may want to consider NFT Loss Harvestooor instead. The platform lets you dispose of your NFTs for free (minus the cost of gas), but you can only process one at a time, making it time-consuming for large collections.
Before using these platforms, you should discuss them with your accountant or other tax professional to ensure the write-offs meet the IRS’ criteria.
Other Ways to Reduce Your Taxes
Tax loss harvesting isn’t the only way to reduce your taxes.
Start by using crypto tax software if you haven’t already done so. ZenLedger and other solutions aggregate transactions across wallets and exchanges to better understand your tax picture. At a glance, you know how much you owe and where opportunities exist to harvest losses.
ZenLedger makes it easy to import transactions from popular exchanges or wallets. Source: ZenLedger
Next, consider minimizing your capital gains with these strategies:
- Hold assets for over a year before selling them to pay the lower long-term capital gains tax rate. Otherwise, you’ll owe the ordinary income rate.
- Buy and sell crypto assets in a self-directed IRA (SDIRA) to reduce your taxable income or avoid paying capital gains taxes.
- Consider specific identification instead of FIFO or LIFO to minimize the capital gains taxes you pay every time you sell.
- Try taking out a crypto loan—which doesn’t trigger taxes—rather than selling crypto assets if you have a short-term need for capital.
- Deduct gas and other transaction fees from your capital gain (or enhance your loss).
If you’ve already incurred capital gains, fewer options exist to reduce your year-end tax burden outside of tax loss harvesting.
Frequently Asked Questions
Can You Harvest NFT Losses?
Yes, the IRS considers NFTs “property,” which means they’re eligible for tax loss harvesting like a stock, bond, or fungible crypto asset. While the process is similar to tax-loss harvesting for stocks or cryptocurrencies, NFTs are less liquid and not fungible, complicating the process.
How Do You Harvest NFT Losses?
You can harvest NFT losses by selling the crypto assets for a loss in an arm’s length transaction. The easiest way to do this is using a service like Unsellable NFTs or NFT Loss Harvestooor, which handles the transaction from start to finish.
What is the NFT Tax Loophole?
Some consider services like Unsellable NFTs and NFT Loss Harvestooor to be a tax loophole because they provide an arm’s length transaction (in theory) while ostensibly enabling you to dispose of your NFT.
How Do You Claim Crypto Losses on Taxes?
You claim crypto losses on your taxes by including the capital loss on Form 8949 and using it when computing the aggregate amount carried over to Form 1040. The loss will offset other capital gains on Form 8949 and up to $3,000 in ordinary income.
The Bottom Line
Tax loss harvesting is an excellent strategy to derive some value from any worthless NFTs you own. You can offset other capital gains or up to $3,000 in ordinary income each year by realizing the loss. And you can carry any losses you can’t use into future years. The key is following the rules and documenting your trades.
If you trade crypto assets, ZenLedger can help you organize transactions across wallets and exchanges to understand better the taxes you owe, help find ways to minimize that number, and then support you through the tax filing process.
The above is for general info purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.
