Even After Tax Season, NFTs Continue to Cause Accounting Problems.

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With the individual tax filing deadline rapidly approaching, it’s tempting for accounting and financial planning professionals to put cryptoassets on the back burner. A tempting option, but one that would do the profession a disservice, as the cryptoasset landscape continues to evolve at a breakneck pace. By focusing exclusively on the numerous issues that arise from the cryptoasset ecosystem on a quarterly or annual basis, practitioners and clients are left in the dark and in need of clarity and answers. While some may view non-fungible tokens (NFTs) as the latest fad or iteration of cryptoassets that must be dealt with, there are fundamental distinctions that accounting professionals should keep in mind moving forward.

 

TAX & NFTs

 

It’s understandable why accounting professionals would want to avoid focusing exclusively on NFTs, given the number of other crypto-related issues that have gained prominence late. Stablecoins, decentralized finance, impending regulatory changes surrounding both issues, and a dearth of authoritative guidance from accounting standard setters have combined to leave the accounting profession with the unenviable task of developing standards based on market consensus and best practice. Even though the cryptoasset sector has come a long way since the early days of bitcoin dominating every conversation, and despite the emergence of numerous other crypto accounting issues, NFTs deserve additional attention.

Consider a few of the accounting-specific issues that NFTs have created, and will continue to create, for the accounting profession as taxes fade from the news.

Each NFT is unique. This is perhaps a self-evident statement, but it is easily overlooked. Due to the instrument’s very name, a non-fungible token, each and every NFT must be assessed and accounted for individually. Along with increasing the attractiveness of this cryptoasset from a purchasing and ownership standpoint, this complicates the task of accurately valuing these instruments. Compounding the need for individual instrument evaluation, NFTs are not universally issued by centralized organizations.

Combining these factors means that each NFT can – and frequently does – have a different accounting value depending on the marketplace or source used. This lack of standardization also complicates and lengthens financial planning – whether investing or tax – because these valuations can, and frequently do, change.

Taxes on NFTs can vary. To add to the accounting complexity surrounding NFTs, the tax treatment of these instruments can vary significantly depending on 1) how the NFT is created and 2) how the investor acquired the NFT. Simply put, taxpayers may be assessed tax rates based on their ordinary income, capital gains, or as a collectible asset, depending on the specifics of their tax situation. The IRS’s and other tax authorities’ failure to establish standards and provide clarity on these issues continues to complicate these issues.

This also means that, from an accounting and financial planning perspective, investors may inadvertently end up owing larger tax bills than might have been anticipated, if any planning had been done at all. Throughout this current tax season, investors have been caught off guard by tax liabilities incurred as a result of crypto trading activities. With NFTs only gaining prominence in 2021, this is something that accountants and advisors will need to plan for as 2022 progresses.

Accounting and financial reporting. Apart from the tax implications of NFTs, they also complicate the questions and considerations that investors must assess from a financial reporting perspective. This question also emphasizes the rapidly growing and changing nature of the non-fungible token subsector of the cryptoasset space, as well as the evolving nature of the financial instrument itself. While it is true that NFTs began as a tool or concept that was exclusively associated with or connected to digital artwork or virtual assets, this trend is reversing.

 

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While tokenization of ownership over physical assets is not a novel trend or development, it has been resurgent in recent years due to the growing interest in NFTs. Whether it is the CityDAO project or physical ownership of real estate, the implications of NFTs on physical assets will raise a slew of accounting and financial issues.

For instance, if an NFT is associated with a real estate development or project, what are the tokenholders’ ownership rights and obligations? Assuming that these rights and obligations can be assessed and comprehended, how do these items affect the token’s valuation? Additionally, will these valuations have an effect on how these NFTs are reported by the aforementioned investors? These are just a few of the numerous questions and unresolved issues that accounting professionals should consider as they move forward.

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NFTs continue to grow in popularity and continue to dominate the cryptoasset conversation, with both individuals and institutions showing interest in and allocating capital to this latest iteration of crypto. As this interest grows, however, accounting and financial reporting issues will begin to surface. While complicated, these questions and open items are not insurmountable for motivated, engaged, and proactive members of the profession. As is customary, accountants who engage with clients and colleagues proactively will be able to provide superior service and insights to both clients and the profession as a whole.

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