In this post, I’ll be answering questions from the CyberBroker’s community about NFT taxation! I’ll help you understand how to deal with NFTs in CyberBroker’s collections and NFTs in general.
Questions from the CyberBroker’s community:
- At the point of claiming a Mech Part, how do you establish the initial cost basis?
- How does this cost basis evolve or transition through the subsequent stages: from revealing the Mech Part, to assembling it into a Genesis Mech, and eventually disassembling it?
- Given that each stage results in a new asset as per the IRS, how is the cost basis recalculated at every step?
The following will answer the questions above and will also show in general how you can treat NFT to NFT trades.
When you first claim a mech part, you figure out its cost basis by dividing the gas fee by the number of NFTs you got. Let’s say the gas fee was 0.1 ETH, and 1 ETH is worth $2,000. If you got 5 mech parts, here’s what it looks like:
Data example:
- Sell – Gas – $200
- Buy – Mech #1 – $40
- Buy – Mech #2 – $40
- Buy – Mech #3 – $40
- Buy – Mech #4 – $40
- Buy – Mech #5 – $40
Data example with a mint fee:
- Sell – Gas – $200
- Sell – ETH – $400
- Buy – Mech #1 – $120
- Buy – Mech #2 – $120
- Buy – Mech #3 – $120
- Buy – Mech #4 – $120
- Buy – Mech #5 – $120
When you exchange mech parts for revealed mech parts, you can choose between two options:
- Use the original cost basis of the mech parts as the value of the trade, otherwise known as the proceeds.
- Use the fair market value of either collection.
In option 1, if you swap one mech part for one revealed mech part, think of it this way: The mech part cost $40 originally. So you sell the mech part for $40, and you buy the revealed mech part for $40 plus the gas fee, which let’s say was $10. In total, the cost basis of the revealed mech part is $50.
Data example:
- Sell – Gas – $10
- Sell – Mech Part – $40
- Buy – Revealed Mech Part – $50
In option 2, you’d figure out the value based on the fair market price of a mech part or a revealed mech part. Since they are a one-to-one match, let’s say fair market value at the time was $100.
Data example:
- Sell – Gas – $10
- Sell – Mech Part – $100
- Buy – Revealed Mech Part – $110
If the cost basis on the mech part was $40, then it incurred a $60 capital gain.
Personally, I am a fan of option 1 because determining NFT fair market values is quite convoluted and unreasonable most of the time. Also what is a NFT’s fair market value is debatable in of itself.
The same options apply for acquiring a mech and disassembling a mech.
Acquiring Mech Data Examples using the above cost basis and fair market values:
Option 1 – Cost Basis Data example:
- Sell – Gas – $10
- Sell – Revealed Mech Part #1 – $50
- Sell – Revealed Mech Part #2 – $50
- Sell – Revealed Mech Part #3 – $50
- Sell – Revealed Mech Part #4 – $50
- Sell – Revealed Mech Part #5 – $50
- Buy – Mech #1 – $260
Option 2 – Fair Market Value Data example:
- Sell – Gas – $10
- Sell – Revealed Mech Part #1 – $100
- Sell – Revealed Mech Part #2 – $100
- Sell – Revealed Mech Part #3 – $100
- Sell – Revealed Mech Part #4 – $100
- Sell – Revealed Mech Part #5 – $100
- Buy – Mech #1 – $510
Disassembling Mech Data Examples using the above cost basis and fair market values:
Option 1 – Cost Basis Data example:
- Sell – Gas – $10
- Sell – Mech #1 – $260
- Buy – Revealed Mech Part #1 – $54
- Buy – Revealed Mech Part #2 – $54
- Buy – Revealed Mech Part #3 – $54
- Buy – Revealed Mech Part #4 – $54
- Buy – Revealed Mech Part #5 – $54
Option 2 – Fair Market Value Data example:
- Sell – Gas – $10
- Sell – Mech #1 – $510
- Buy – Revealed Mech Part #1 – $104
- Buy – Revealed Mech Part #2 – $104
- Buy – Revealed Mech Part #3 – $104
- Buy – Revealed Mech Part #4 – $104
- Buy – Revealed Mech Part #5 – $104
Option 1 doesn’t incur any capital gains or losses, whereas Option 2 does. Whichever you select, stick with it and stay consistent!
More questions from the CyberBroker’s community!
- When trading NFTs or similar assets, how can one assess and handle the original cost basis to accurately determine capital gains or losses during the trade?
You often figure out how much your NFT is worth based on what you used to get it. If you used $100 worth of ETH (that covers the fees and what you spent), then that’s the starting value of your NFT, which we call the cost basis. NFTs usually have a unique ID, like NFT #1234. In most cases, the cost basis method leads to the same result, unless you have lots of the same NFT, which is pretty rare. For trading NFTs with other NFTs, look back at the earlier parts of this post.
- What methods or practices are advisable in accounting for the difference in values between traded assets?
You have two options here:
- Use the higher fair market value. This is the safest option.
- Use the lower fair market value.
Suppose you traded NFT #1234 for NFT #1254, and NFT #1234 is worth $100, while NFT #1254 is worth $120. Here’s what you do: for option 1, use $120 as the value. For option 2, use $100. If you’re not sure about the NFT values, you can look at the earlier parts of this post and use the cost basis instead.
Trading NFTs for other NFTs can be tricky because figuring out their price is complicated. If you keep things consistent and reasonable, it’s unlikely the IRS or tax agencies will have an issue with your methodology on NFT to NFT trades.
