NFTs continue to cause accounting problems, even after tax season
As the deadline for filing personal income tax returns quickly fades into the rearview mirror, 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 crypto-asset landscape continues to develop at an accelerated pace. Only paying attention to the many issues that arise from the crypto-asset ecosystem on a quarterly or annual basis leaves practitioners and clients scrambling for clarity and answers. Non-fungible tokens (NFTs) may be considered by some to be the latest fad or iteration of crypto-assets to contend with, but there are some fundamental differences accounting professionals should keep in mind as they move forward. ‘before.
It’s easy to see why accounting professionals wouldn’t want to focus specifically on NFTs, as there are many other crypto issues that have come to prominence lately. Stablecoins, decentralized finance, impending regulatory changes around these two issues, and the lack of authoritative guidance from accounting standard setters have all combined to leave the accounting profession with the unenviable task of developing standards by market consensus and best practices. Even though the crypto-asset industry has come a long way since the early days when bitcoin dominated all conversations, and many more crypto accounting issues have surfaced, NFTs deserve extra attention.
Let’s take a look at some of the accounting-specific problems that NFTs have created, and will continue to cause, for the accounting profession, even if taxes disappear from the headlines.
Every NFT is different. This may be an obvious statement, but one that can easily be overlooked. The very name of the instrument, a non-fungible token, means that by default each NFT must be valued and accounted for on an individual basis. In addition to making this cryptoasset attractive from a buying and owning perspective, it makes it difficult to properly value these instruments. In addition to the need to evaluate instruments on an individualized basis, NFTs are not universally issued by centralized organizations.
The combination of these factors means that, from an accounting perspective, each NFT can – and often does – have different valuations depending on the market or source used. This lack of standardization also makes financial planning – whether investment or tax – more difficult and time-consuming since these assessments can and do change.
NFT fees may vary. The accounting complexity surrounding NFTs is compounded by the fact that the taxes imposed on these instruments can vary widely depending on 1) how the NFT is created and 2) how the investor in question came to own the NFT. . To put it simply, taxpayers can be assessed tax rates either at the ordinary tax rate, or at the capital gains rate, or as a recoverable asset depending on the specifics of the tax situation. The lack of standards and clarity on these issues from the IRS or other tax authorities continues to complicate these issues.
From an accounting and financial planning perspective, it also means that investors may inadvertently end up paying larger tax bills than might otherwise have been expected, had planning been done. . Stories have abounded during this current tax season of investors caught off guard over tax liabilities as a result of crypto trading activities. With NFTs only gaining prominence in 2021, this is definitely something accountants and advisors will need to plan for as 2022 continues to move forward.
Financial report. Aside from the specific tax issues generated by NFTs, they also complicate the issues and considerations that investors must assess from a financial reporting perspective. This question also highlights the rapid growth and rapid evolution of the NFT sub-sector of the crypto-asset space; the changing nature of the financial instrument itself. While it is true that NFTs may have originated as a tool or concept that was only related or connected to digital artworks or virtual assets, this trend is changing. .
The tokenization of ownership of physical assets, while not a new trend or unique development, has been invigorated by the growing interest in NFTs. Whether it is the CityDAO project or the physical ownership of real estate projects, the implications of NFTs related to physical assets will create a host of accounting and financial issues.
For example, if an NFT is related to a real estate development or project, what are the ownership rights and obligations of the token holders? Assuming these rights and obligations can be valued and understood, how do these elements impact the valuation of the particular token? Furthermore, will these valuations influence the way these NFTs are reported by the investors in question? These are just a few examples of the many questions and open questions accounting professionals should consider moving forward.
NFTs continue to grow and dominate the crypto-asset conversation, with individuals and institutions taking interest and allocating capital to this new iteration of crypto. However, as this interest continues to grow, accounting and financial reporting issues will begin to surface. These open questions and points, while complicated, are not insurmountable for motivated, committed and proactive members of the profession. As always, accountants who proactively engage with clients and colleagues will be able to provide better service and information to clients and to the profession as a whole.