Value is in the eye of the beholder; or was that beauty? This is especially true for those infamous monkey portraits on the internet. Non-fungible tokens (NFTs) have exploded in popularity and can carry with them substantial tax consequences. Due to the volatile nature of the digital asset market and coupled with the lack of similar assets, it can be exceptionally difficult to determine the fair market value (FMV) of NFTs. Gift giving and donations can become much more complicated when using NFTs.
New-Fangled Technology
For the noobs, an NFT is a type of cryptographic token that exists on a blockchain.[1] As the name suggests, the tokens are not fungible, meaning each asset is unique and can’t be interchanged for one another, the way that dollars or bitcoins can. Every NFT represents a unique asset with a unique value, however, determining what that value is can be quite difficult. The market for buying and selling NFTs can be extremely volatile. Some NFTs may quickly lose value or have no value at all. When a taxpayer donates an NFT to a qualified charitable organization as a way to reduce tax, the FMV is a required piece of information.
Now Feeling Totally (Generous)
A taxpayer who donates property to a charitable organization is typically allowed to deduct some or all the value of that deduction on Schedule A.[2] When contributing appreciated capital gain property, if you held on to said property for less than a year, then the amount of the Schedule A deduction is the taxpayer’s adjusted basis in the property.[3] However, if the property has been held for more than a year, the taxpayer can deduct the FMV of the property.[4] That presents an excellent tax saving opportunity for the taxpayer because they get to both side-step paying capital gains tax and also get a deduction for the higher FMV instead of the original basis. So how does the taxpayer actually determine the FMV of these highly volatile assets?
Never Figuring (out the) Tax
As luck would have it, the IRS has created an entire publication dedicated to determining the FMV of charitable contributions.[5] As of this writing, It does not mention NFTs once. However, we can extrapolate from the existing rules to get some ideas of how to value an NFT. The general definition of FMV is “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.”[6]
When trading an NFT for green dollars, it becomes quite easy to determine the price since the price is always denominated in dollars. When donating or trading an NFT for other property (like another NFT), the value determination becomes much more subjective.
The courts have held that when the value of one side of a taxable trade is unknown, that both the proceeds of the property being disposed of and the basis of the item being acquired are equal to the FMV.[7] That means if the FMV is known for one half of the trade, it can be applied to both halves. This isn’t as helpful when the property is being donated and there isn’t anything received in return, though we can extrapolate from this logic in our determination.
While at the time of this writing, only a small number of charitable organizations accept (or even seek out) NFT contributions. However, the number is quickly growing and NFT donations worth millions of dollars are becoming more commonplace.[8] Whether or not the charity ultimately keeps or sells the NFT can help inform the FMV. Many charities that accept property, whether clothing, stock, cars, or NFTs, do so with the intent of selling the property shortly after acquisition to convert the property into liquid cash to further the organization’s charitable mission.
If the charity sells the NFT, it will typically be for dollars or for a fungible cryptocurrency (such as Ethereum) that has a widely accepted market value. In that case, and barring any extenuating circumstances such as an overall market crash in the intervening period, the FMV of the contribution is typically equal to the proceeds of the subsequent sale.
If the charity doesn’t immediately liquidate the NFT, it may make the value determination more complicated. Another method to help determine value is comparable sales. Many NFT projects are part of larger collections, sometimes numbering in the thousands or tens of thousands of tokens. Like all collectibles, some individual pieces become more desirable than others, creating a range of value within a particular project.
One benefit of NFT sales is that the data is readily available on the blockchain, with sales price and date and time of the sale easily accessible. Having this information available can facilitate finding recent comparable sales for an NFT with similar attributes to the one contributed. An additional option would be to average the most recent high and low sales price (or a few of them) to determine an average value.
A more conservative position would be to use the value of the lowest value NFT in the recently sold project (commonly referred to as the project “floor”). The comparable sales method is fairly subjective, so it is imperative to document how the FMV was determined and explain the methodology.
Contributions with a value of more than $5000 must have the FMV determined via a qualified appraisal.[9] A qualified appraiser will use a number of tools, including their own expertise and experience to arrive at an FMV. Appraisers typically associate with the art world, but the NFT appraisal industry is quickly developing online. While appraisals are necessary for contributions over $5000, appraisers can still perform them on donations under the threshold. This may be a viable option when other methods prove insufficient. It is imperative that a taxpayer using an appraisal service conducts due diligence to confirm the appraiser meets IRS standards. The exact requirements are outside of our scope, but consult IRS publication 561 for further details.
The innovative smart contract technology available to NFTs adds an additional layer of complexity to NFT contributions when compared to more traditional donations. Smart contracts can allow for redirection of payment on subsequent sales to the original creator or other parties. Some charitable projects market themselves on returning a percentage of subsequent sales to the original donor. This can substantially influence FMV because the taxpayer must reduce the FMV of the contribution by “goods or services received or expected to be received in return.”[10]
As with all charitable contributions, it’s imperative the taxpayer acquires and retains comprehensive documentation regarding the contributions. Many, if not most, contributions will require contemporaneous written acknowledgement from the charitable organization or the taxpayer risks having the donation removed from the return.[11] The tax court is known for being extremely inflexible in this area and holding taxpayers accountable for the wording and timing in the statute.[12]
New-found Takeaways
NFTs bring with them new opportunities for novel charitable giving. The non-fungible nature and ability to receive deferred consideration can make determining the FMV of an NFT exceptionally difficult. Comprehensive, contemporaneous documentation and following methods outlined in Pub. 561 can help make the contribution process much less taxing for the donor.
[1] Noobs are the uninitiated.
[2] IRC § 170(a).
[3] IRC § 170(e)(1)(A).
[4] IRC § 170(b)(1)(C)(iv).
[5] IRS Pub 561.
[6] Treas. Reg § 1.170A-1(c)(2).
[7] Philadelphia Park Amusement Co. v. United States, 126 F. Supp. 184 (Ct. Cl. 1954).
[8] https://thegivingblock.com/resources/nonprofits-nfts-explained-a-new-vision-for-charitable-fundraising/.
[9] IRC § 170(e)(11)(C).
[10] Treas. Reg § 1.170A-1(h)(2)(B).
[11] IRC § 170(f)(8)(C).
[12] Izen v. Commissioner, CA5, Docket No. 21-60679, June 29, 2022; Keefer v. United States, USDC ND TX, Case No. 3:20-cv-00836, July 6, 2022.
