With the filing deadline for individual tax returns quickly fading into the rearview mirror, it is tempting for accounting and financial planning professionals to put cryptoassets on the proverbial back burner. A tempting option, but one that would be a disservice to the profession, as the cryptoasset landscape continues to develop at an accelerating rate. Only paying attention to the numerous issues that arise from the cryptoasset ecosystem on a quarterly or annual basis leaves practitioners and clients scrambling for clarity and answers. Non-fungible tokens (NFTs) might be seen by some as just the latest fad or iteration of cryptoassets that need to be contended with, but there are fundamental differences that accounting professionals should keep an eye on moving forward.
It is easy to understand why accounting professionals would not want to focus on NFTs specifically, as there are many other crypto issues that have risen to prominence as of late. Stablecoins, decentralized finance, looming regulatory changes around both issues, and the lack of authoritative guidance from accounting standard setters have all combined to leave the accounting profession with the unenviable task of making standards by market consensus and best practice. Even though the cryptoasset sector has moved quite a long way from the early days of bitcoin dominating every conversation, and many other crypto accounting issues have popped up, NFTs are worthy of additional attention.
Let’s take a look at s few of the accounting specific issues that NFTs have created, and will continue to cause, for the accounting profession even as taxes fade from the headlines.
Every NFT is different. This is perhaps an obvious statement, but on that can easily be overlooked. The very name of the instrument, a non-fungible token, means that by default every single NFT needs to be assessed and accounted for on an individual basis. In addition to making this cryptoasset interesting from a purchasing and ownership perspective, this makes the correct valuation of these instruments a difficult task. Compounding the necessity of evaluating instruments on an individualized basis, NFTs are also not universally issued by centralized organizations.
Combining these factors means that, from an accounting perspective, every single NFT can -and often do – have different valuations depending on what marketplace or source is utilized. This lack of standardization also makes financial planning – either investing or tax – more difficult and time consuming since these valuations can, and often do, change.
NFT taxes can vary. Adding to the accounting complexity surrounding NFTs is the reality that the taxes assessed on these instruments can vary quite a bit depending on 1) how the NFT is created, and 2) how the investor in question came to own the NFT. To state it simply, taxpayers can be assessed tax rates at either the ordinary tax rate, at the capital gains rates, or as a collectible 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 questions.
From an accounting and financial planning point of view this also means that investors can inadvertently end up owing larger tax bills than otherwise might have been planned for, if any planning had been done at all. Stories abounded during this current tax season of investors caught unawares of tax liabilities as a result of crypto trading activities. With NFTs only having come to prominence during 2021 this is definitely something that accountants and advisors will have to plan for as 2022 continues to roll forward.
Financial reporting. Setting aside the tax specific issues that are generated as a result of NFTs, they also further complicate the questions and considerations that investors need to assess from a financial reporting perspective. This question also highlights the fast growing and rapidly changing nature of the NFT subsector of the cryptoasset space; the changing nature of the financial instrument itself. While it is true that NFTs might have originated as a tool or concept that was only linked or connect to digital artwork or virtual assets, this trend is changing.
Tokenization of ownership over physical assets, while not a uniquely new trend or development, has been reinvigorated by the rising interest in NFTs. Be it the CityDAO project, or physical ownership of real estate projects, the implications of NFTs linked to physical assets will create a multitude of accounting and financial related questions.
For example, if an NFT is linked to a real estate development or project, what are the ownership rights and obligations of the tokenholders? Assuming that these rights and obligations are able to assessed and understood, how do these items impact the valuation of the particular token? Additionally, are these valuations going to influence how these NFTs are reported by the investors in question? These are just a sampling of the many questions and open items that accounting professionals should consider moving forward.
NFTs continue to grow and dominate the cryptoasset conversation, with individuals and institutions alike becoming interested and allocating capital to this newest iteration of crypto. As this interest continues to increase, however, there are accounting and financial reporting issues that will begin to come to the surface. These questions and open items, while complicated, are not insurmountable for motivated, engaged, and proactive members of the profession. As always, accountants who proactively engage with clients and colleagues will be able to provide better service and insights to both clients, and the profession at large.