NFTs: Treating Capital Gains in Puerto Rico’s Crypto Utopia
- Posted: February 6, 2023
- Posted by: Travis Lynk
- Last Reviewed: February 24, 2023
Many investors are reaping the benefits of trading NFTs, but not all are familiar with the tax implications and the advantages of doing so from Puerto Rico. We break it down for you below.
- Are NFTs Taxed When You Sell Them?
- Are NFTs Taxed When You Buy Them?
- Are NFTs Taxed When They’re Created?
- Reporting NFT Transactions and Calculating Taxes
- Move to Crypto-Friendly Countries
- Don’t Relocate with Your Current Crypto
- How to Reduce Taxes on NFTs While Still on the Mainland
- Apply for Puerto Rico Crypto Tax Savings
Keep More of Your NFT Profits
It didn’t take long for digital assets called non-fungible tokens (NFTs) to surge from obscurity to mainstream investment options and collectors’ items. Trading in NFTs exploded by an astounding 21,000% between 2020 and 2021, reaching a record $17 billion in trading volume by January 2022. With booming interest in NFTs, major media outlets have reported on multimillion-dollar NFT transactions.
NFT traders are turning large profits, with a collection of NFTs by Beeple selling for a staggering $69.3 million in 2021. However, some traders are unaware of the tax implications of buying and selling them.
This article outlines what you should keep in mind when you trade NFTs and how you can make capital gains work for you from your new home in crypto-friendly Puerto Rico.
What Are NFTs?
NFTs are digital representations of assets verified by blockchain technology. For example, an NFT might be a JPEG, GIF, or MP4. Each NFT contains a unique identification code that sets it apart from other NFTs. Unlike physical currency, which is fungible—for example, one dollar bill is equal to another dollar bill—NFTs are non-fungible. A particular NFT has a unique value, belongs to one owner, and cannot be duplicated or exchanged freely with another.
NFTs simplify trading methods and loan systems for different asset types, from artwork to real estate, by “tokenizing” real-world tangible assets. Some have considered using NFTs for car titles, identification, or house deeds, because NFTs can’t be counterfeited. They can securely hold the ownership rights of physical assets and make transactions simpler without intermediate agents. Essentially, they are digital assets based on tangible assets.
But don’t forget about taxes.
How Are NFTs Taxed?
NFT gains are taxable most of the time in most places because NFTs are considered property, like other crypto assets.
Since NFTs are digital versions of assets, a capital gain or loss occurs every time you sell an NFT. We’ll walk you through these in greater depth below.
Are NFTs Taxed When You Sell Them?
When your NFT holdings make a profit, you incur a capital gain and must pay a portion of your gains to the IRS. The amount you pay varies depending on how long you held it—your tax rate will be more favorable if you had it for more than a year—and your taxable income.
If you sell an NFT for cryptocurrency, you will owe taxes on the price appreciation between the time you bought and sold the NFT.
Before the second half of 2022, selling an NFT piece of art also resulted in a higher 28% tax rate because it was being treated as a collectible, not a capital asset.
Crypto-to-crypto transactions—such as trading cryptocurrency for NFTs and selling those NFTs for cryptocurrency—are taxable events.
Are NFTs Taxed When You Buy Them?
When you buy NFTs, you generally don’t have to pay taxes on the transaction if you buy them with cash.
However, many NFT marketplaces will require you to purchase them with cryptocurrency. If you buy NFTs with cryptocurrency, you may have to pay taxes if the value of that cryptocurrency rose since you acquired it. And if you’ve owned the cryptocurrency for less than a year, you’ll pay a higher rate than if you’ve owned it for more than a year.
Only a few states, like Pennsylvania and Washington, consider NFTs subject to sales tax. However, we can’t exclude the possibility that Puerto Rico will implement a similar arrangement down the road. For now, handling of the sales tax responsibility lies with the seller, not the buyer.
Are NFTs Taxed When They’re Created?
Creating, or minting, an NFT is not a taxable event until the NFT is actually sold. Upon selling the NFT, the difference between the cost to create it and the profit received is taxable income. Regular income tax brackets and self-employment taxes will apply.
Reporting NFT Transactions and Calculating Taxes
To report sales of NFTs, you use Form 8949, the same way you would report trading in cryptocurrency.
When you sell NFTs, you’ll have to calculate either short- or long-term capital gains tax depending on the length of time you owned them.
If you do a lot of NFT trading, your taxes will get complicated quickly. You can make this easier by calculating your NFT taxes using a crypto/NFT tax software program, such as the ones below. We recommend that you browse these and other programs and select the one that’s the best fit for your specific circumstances:
What Are Capital Gains and How Do They Affect NFTs?
Until recently, there was no strict consensus in the United States on how to treat capital gains on NFTs. The IRS had not formally decided the asset class for NFTs, so NFTs received different types of tax treatment, depending on whether they were considered property or collectibles. Since NFT pieces of art were considered collectibles, they were taxed at a higher 28% rate.
However, in 2022, the IRS issued new guidance that suggests it does not consider NFTs to be collectibles; instead, all NFTs will be treated as property and digital assets, like cryptocurrency. This means all NFTs should be subject to regular capital gains tax rates.
The capital gains incurred due to the buying and selling of NFTs can be of two types:
- Short-term capital gains tax rates apply to NFTs that are sold after a holding period of less than a year. These are rates are the same as ordinary income tax rates and reflect your specific tax bracket, ranging from 10% to 37%.
- Long-term capital gains tax rates apply to NFTs held for more than a year. With a few exceptions, these rates can be 0%, 15%, or 20%, depending on your income.
Differences between Cryptocurrency Tax in the U.S. and Puerto Rico
Since Puerto Rico is a U.S. territory and not a state, cryptocurrency tax laws on the island are different from what you may be used to on the mainland.
Let’s review how NFTs and cryptocurrency (now identical, for tax purposes) are treated on the mainland: profits are considered capital gains, so if you hang onto your cryptocurrency for less than a year before selling it, you incur short-term capital gains taxes.
You’ll get a better tax benefit by holding cryptocurrency for more than a year prior to selling. This results in long-term capital gains taxes.
You’ll have to pay an additional 3.8% for the Net Investment Income Tax if the value of your holdings crosses a particular limit.
In addition, most U.S. states require you to pay capital gains taxes at the state level. The amount varies from state to state.
However, if you relocate from the mainland to Puerto Rico and become a bona fide resident, you can forget about paying those taxes. That’s because of a landmark piece of legislation known as Act 60. Under the Individual Resident Investor Tax Incentive, you’ll pay 0% on capital gains accrued from cryptocurrency during your residency on the island. This is a tremendous tax exemption.
How Can Moving Help with Capital Gains?
Move to Crypto-Friendly Countries
A powerful way to minimize high taxes is to move to a crypto-friendly location.
According to Coincub’s latest crypto tax ranking, the top five countries with the best crypto taxes for residents are as follows:
Each of these countries impose low or no taxes on crypto earnings.
However, moving to one of these countries from the United States would be a difficult transition for many Americans. The legal, cultural, and linguistic differences are substantial.
Furthermore, laws on crypto taxation change frequently. For example, Portugal recently reversed its earlier stance that all proceeds from selling cryptocurrency would be tax free. Digital assets there will be subject to taxes on short-term gains.
Relocating to a foreign country is a major and often costly transition with no guarantee that earlier crypto-friendly policies will last.
There’s an easier way to benefit from low capital gains taxes on crypto earnings: relocate to Puerto Rico. The island is a U.S. territory, but for federal income tax purposes, it’s treated as a foreign country. Puerto Rico has its own tax system.
In Puerto Rico, your crypto gains acquired after becoming a bona fide resident of the island will be exempt from capital gains taxes. Furthermore, moving to the island is a relatively simple transition. You won’t need a visa to relocate, English is one of the island’s official languages (it’s more widely spoken in San Juan than elsewhere on the island), and you’ll retain your benefits from Social Security, Medicare, as well as other legal protections. You won’t even have to convert your U.S. dollars into another currency.
Don’t Relocate with Your Current Crypto
There’s an important caveat to the incentive above; your cryptocurrency gains while a resident on the mainland will still be subject to U.S. capital gains taxes. In addition to mainland federal taxes, you’ll probably be responsible for paying state taxes on your acquired crypto gains before moving to Puerto Rico.
If you expect the value of your crypto investments to take off later, consider selling them off while still a mainland resident.
Then buy them back or acquire promising new crypto assets upon relocating to Puerto Rico. After relocating to the island, your new crypto capital gains will be exempt from taxes.
Alternatively, you can hang onto your current crypto and pay a low (but not zero) tax rate on your gains after becoming a Puerto Rico resident, as we’ll touch on below.
How to Reduce Taxes on NFTs While Still on the Mainland
It takes time for most people to prepare for and complete a move. It’s also easier to meet bona fide residency requirements if you relocate to Puerto Rico during the first half of the year. If you’re not ready to move, think about whether these additional tips to reduce your taxes on NFT profits are appropriate for your situation and intended move date.
- Don’t dispose of your NFTs until you have achieved your equity targets.
- Buy NFTs with cash instead of appreciated cryptocurrency to avoid the tax penalty.
- Keep NFTs for at least a year to avoid higher short-term taxes.
- Dispose of NFTs during low-income years when you’re in a lower tax bracket.
- Use tax loss harvesting to offset gains with losses.
You can also gift up to $16,000 in NFTs to someone else and avoid paying taxes. It’s even possible to exceed that limit and receive a tax exemption on that amount if you meet the following criteria:
- Donate directly to a 501(c)(3) organization.
- Donate an NFT that you held for more than 12 months.
Apply for Puerto Rico Crypto Tax Savings
Once you’ve finalized your plans to relocate to the island, get ready to apply for some of the generous tax incentives offered to qualified residents. You’ll find more than just Puerto Rico crypto tax savings here. The Individual Resident Investor Tax Incentive, a part of the Act 60 program, offers substantial tax benefits to U.S. citizens who become bona fide residents of Puerto Rico.
According to the Act, an individual can enjoy a 100% tax exemption on all short-term and long-term capital gains from NFT sales made after the individual has become a bona fide resident of Puerto Rico. In the case of pre-existing gains, the individual has to pay a tax rate of only 15% if the gain is realized within 10 years of establishing residency, and a rate of 5% if realized after 10 years and by December 31, 2035.
To become a bona fide resident of Puerto Rico and be eligible for these tax breaks, you must meet a series of requirements that include but are not limited to the following:
- Demonstrate to the IRS that you spend more time in Puerto Rico than in the rest of the United States. As a rule of thumb, you must be physically located inside Puerto Rico for at least 183 days of the taxable year.
- Do not keep a “tax home” (the main place where you work and create value) outside of Puerto Rico.
- Show that you have stronger ties to Puerto Rico than to the rest of the United States. The IRS will consider factors such as where your immediate family members and personal belongings are located, where you are registered to vote, and where you hold your driver’s license.
- Buy property in Puerto Rico to use as your principal residence within two years of obtaining the Act 60 tax decree. You must own it yourself or jointly with a spouse, and the property must remain your primary residence for as long as the decree remains in force.
- For each year that the tax decree remains in force, you must make a donation worth $10,000 split between two qualifying nonprofit organizations in Puerto Rico.
Is Puerto Rico a Good Option for Crypto Owners?
As you can see, Puerto Rico is an excellent tax haven for farsighted crypto investors who pay attention to and play by the rules.
If you expect the value of your NFTs and other cryptocurrencies to rise, it would be ideal to realize these gains after you’ve relocated to Puerto Rico.
By relocating to Puerto Rico and meeting all of the bona fide residency requirements, your crypto gains from the day you move will be exempt from taxes.
Ask yourself this: Is it better to pay up to 37% taxes on crypto earnings on the mainland, or 0% in Puerto Rico?
Details vary between transactions and we have not addressed every possible scenario. Furthermore, cryptocurrency tax policies might change down the road, depending on the evolving positions of the IRS and other authorities.
Keep meticulous records of your NFT transactions in case you’re audited because the IRS will expect to see documentation.
Be sure to consult a qualified tax advisor and provide the details about your situation before proceeding with an important NFT transaction.
Catch a Tax Break with PRelocate
With PRelocate’s help, you’ll not only catch some rays at Puerto Rico’s pristine beaches, but also some of the finest federal income tax and other tax breaks around, as thousands of other relocated Americans have discovered. Puerto Rico is a tax utopia for investors in blockchain technology. That’s not all—the island also offers a substantial number of additional tax incentives.
If you have additional questions about moving to the island, contact us today.
Disclaimer: Neither PRelocate, LLC, nor any of its affiliates (together “PRelocate”) are law firms, and this is not legal advice. You should use common sense and rely on your own legal counsel for a formal legal opinion on Puerto Rico’s tax incentives, maintaining bona fide residence in Puerto Rico, and any other issues related to taxes or residency in Puerto Rico. PRelocate does not assume any responsibility for the contents of, or the consequences of using, any version of any real estate or other document templates or any spreadsheets found on our website (together, the “Materials”). Before using any Materials, you should consult with legal counsel licensed to practice in the relevant jurisdiction.
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