For high net worth individuals, tax strategies and investing go hand-in-hand. If youâ€™re not diligent about the tax consequences of your investments, you may owe the IRS far more than anticipated. As such, these wealthy individuals often ask our team about the potential tax savings of different investments. Recently, weâ€™ve fielded questions about investing in art and non-fungible tokens, or NFTs, for tax savings. In this article, weâ€™ll explain how investing in these asset classes can earn you some serious NFT tax savings.
Specifically, weâ€™ll cover the following topics:
- Art, NFTs, and Taxes
- How to Get Art Tax Deductions
- Potential Tax Deductions for Buying Art
- How to Get NFT Tax Deductions
- Potential Tax Deductions for Buying NFTs
- More Advanced Tax Strategies for High Earners
Art, NFT, and Taxes
Many high-net-worth individuals choose to invest in art. They purchase valuable paintings, sculptures, or other pieces of art for two primary reasons. First, these items traditionally hold their value. That is, unlike the stock market, the value of a painting isnâ€™t likely to drop significantly. Second, major upside potential exists with art, with the possibility of items increasing in value over the long term.
Non-fungible tokens, or NFTs, are in some ways a modern variation on art. According to the Journal of Accountancy, an NFT is: a unique (nonfungible) digital code (token) that represents one or more specific items of text, image, video, and/or music, and possibly also information about and rights in that content. And, over the past year: several artistic creators have recently â€œtokenizedâ€ their original works and sold the resulting NFTs for jaw-dropping prices through online auctions. Essentially, some wealthy individuals now view NFTs as a form of digital art that offers the same potential benefits to investing in traditional art.
Art vs. NFTs
Currently, the IRS has not issued authoritative guidance on the treatment of NFTs. However, initial guidance suggests that, from an investorâ€™s perspective, they will receive similar tax treatment to art.
The IRS classifies art as collectibles. Accordingly, when you sell a work of art held for more than a year at a gain, you face the collectible’s long-term capital gains rate of 28%. As with all capital assets, gains on holding periods for a year or less are subject to ordinary income tax rates (i.e. your marginal tax rate).
Unless the IRS publishes authoritative guidance to the contrary (which appears unlikely), NFTs will continue to be treated as collectibles. That is, NFTs held for more than a year will face the collectibles-specific capital gains rate of 28%. This rate should be viewed in terms of the standard capital gains rates of 0%, 15%, or 20%, depending on your income bracket. In other words, individuals who invest in art or NFTs will actually pay a higher tax rate than they would for investments in other capital assets.
How to Get Art Tax Deductions
While investing in art results in higher capital gains rates, you may be able to deduct certain art-related expenses. Receiving deductions for purchasing art depends on how the IRS classifies your activities. As a collector, you cannot deduct any expenses related to the purchase, transportation, or maintenance of a piece of art. Alternatively, you may receive investor status. In this case, the IRS lets you deduct these expenses.
However, to receive the investor classification, you must demonstrate that your interest in art is more than a hobby. That is, you must demonstrate that you collect art primarily for investment purposes, meaning you seek to sell art for a profit. If you have never sold a piece of art, the IRS will likely classify you as a collector, disallowing any related deductions.
Potential Tax Deductions for Buying Art
If the IRS considers you an investor, you can deduct the ordinary expenses associated with purchasing, transporting, and maintaining art. Some common expenses include the following:Â
- Art appraisal services
- Fees paid to an art broker
- Fees paid to an auction houseÂ
- Climate-controlled transportation of art from point-of-sale to final destination
- Storage fees
- Rehabilitation and conservation servicesÂ
How to Get NFT Tax Deductions
Unlike with art, the IRS has yet to classify distinct categories of people who purchase NFTs (i.e. collectors vs. investors). However, assuming this distinction does arise, investors will have far fewer options for NFT tax deductions than with art. As a digitized item, there are few expenses (if any) related to the purchase, transportation, or maintenance of NFTs.
Investing in NFTs will actually trigger larger tax bills. Currently, investors can only purchase an NFT with cryptocurrency (e.g. Bitcoin, Ethereum, etc.). And, the IRS views crypto as property – not currency. Therefore, when you use cryptocurrency to purchase an NFT, you have a taxable event.
For example, say you bought some cryptocurrency two years ago for $1,000. It has now grown in value to $10,000, and you use that $10,000 in crypto to purchase an NFT. The IRS would view this as a sale of property, and you would recognize a $9,000 long-term capital gain on the â€œsaleâ€ of that cryptocurrency, even though you only used it to purchase an NFT.
Furthermore, if you ultimately sell that NFT for gains, you will incur the 28% capital gains rate used for collectibles – not the more favorable 0%, 15%, or 20% long-term capital gains rates. Bottom line, investing in NFTs does not appear to offer any significant tax savings. Quite the opposite, this strategy forces investors to pay more in taxes than they would with other capital assets.
Potential NFT Tax Deductions
If the IRS decides to offer investors in NFTs the same tax classifications as investors in art, some tax deductions may exist. While you will not incur any transportation expenses due to the digital nature of NFTs, you may face purchase and â€œstorageâ€ fees. For instance, if an NFT sales platform charges a commission for a sale, that would likely qualify as a deductible, purchase-related expense. Similarly, if you must pay for specific software to store and secure your collection of NFTs, that would likely qualify for a tax deduction.
Advanced Tax Strategies for High Earners
Investing in art and NFTs may not provide the tax savings that many people initially believe. With that said, potential tax deductions do exist. And, at Shared Economy Tax, we live and breathe tax savings for high net worth individuals, so contact us to set up a tax planning strategy session!