The non-fungible token (NFT) market has grown into a multibillion-dollar sector of the crypto industry, with top collections like CryptoPunks and Bored Ape Yacht Club trading for tens of millions of dollars or more.

Needless to say, it’s been a wild year for NFT investors, who should use the last few weeks of 2021 to prepare for tax season in April.

“Right now in December – before the year ends – you want to have an understanding of what your tax position is and your capital gains amount,” says Kate Waltman, a New York-based certified public accountant who specializes in crypto.

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Just last year, says Waltman, the average client rarely asked his or her accountant or advisor about the tax implications of holding crypto and NFTs.

“But this year crypto has been a big part of the conversation,” Waltman says. “And I would say in the last four or five months this became the year that [clients] started paying attention.”

And so has the U.S. Internal Revenue Service: “The IRS is absolutely putting a focus on crypto activity,” says Waltman. “While they may not have the ideal infrastructure set up yet to be tracking and evaluating a lot of these crypto transactions, what I can tell you is that it’s a focus area.”

Help your clients prepare for tax season – even if they don’t plan on selling any NFTs this year. Read on to learn five important tax tips for NFT investors.

The IRS classifies cryptocurrency as property rather than currency, Waltman says. So when you buy an NFT using cryptocurrency – like most NFT transactions – you’ll technically be buying and holding an asset for a short period of time.

“For 98% of NFT purchases, you need to use some form of cryptocurrency,” such as ETH, SOL or ADA, Waltman says. “By virtue of buying cryptocurrency, and holding it for a short period of time, you’re going to have a fluctuation in valuation of that cryptocurrency and then when you use that crypto to purchase an NFT.”

The IRS therefore sees NFT transactions as a simultaneous sale of your cryptocurrency and purchase of a new asset which is an NFT, therefore resulting in a capital gain or loss. Fortunately, platforms like CoinTracker provide a way to track your NFTs and more easily calculate capital gains.

“However, if you purchase an NFT using U.S. dollars, which is possible on some platforms, that’s not a taxable event,” Waltman says.

“The important thing to keep in mind with selling an NFT that you previously purchased is whether or not you fall into the short-term capital gains bucket or the long-term capital gains bucket,” Waltman says.

The short-term capital gains bucket would mean that your client bought and sold an NFT within a 12-month period of time. If clients fall into the short-term capital gains bucket, their tax amount is their ordinary income tax rate.

If your client bought an NFT and held it for a minimum of 12 months and one day, then sold it, the client falls into the long-term capital gains bucket. The long-term capital gains rate is either 0%, 15%, or 20%, depending on what their overall income amount is.

“For most people it’s 15%, and 15% is, generally speaking, lower than what your ordinary income tax amount would be,” Waltman says. “It’s usually advantageous from a tax perspective to try to fall into the long-term capital gains bucket and hold for 12 months and one day so you can reduce your tax bill.”

Social media giveaways are common in the NFT world. They usually come in the form of an airdrop, where an NFT creator or artist shares tokens with a community or follower base.

“If you’re receiving an airdrop from a giveaway that you won or a prize of some kind, you’ll likely know to expect that because you’ll be notified,” Waltman says. Whether your client has been involved in a new launch, commented on a particular thread or in a Discord channel, they should get a heads-up that an NFT is on its way to them.

While this is part of the thrill of NFT collecting, your clients should know the tax consequences.

“A lot of people have been sort of hoping that if you win a giveaway or an airdrop there are not going to be taxes. But as we know, the IRS always wants a piece of prizes and giveaways,” Waltman says.

Prizes and giveaways are going to be taxable at your clients’ ordinary tax rate (the USD equivalent value). This might be subjective, given the volatile and nascent nature of NFTs. But an accountant can use market data and blockchain records to confirm the estimated value of the NFT asset.

“A project like that has a well-established floor price will have a fair market value that is pretty readily available and easily determinable,” Waltman says. “Similarly, other blue-chip, verified NFT projects would also be pretty easy to determine what the USD equivalent value is. You can go to OpenSea or another NFT trading platform and look at the floor price and look at other comparable recent sales and determine the fair market value pretty easily.”

For newer projects that have just been created, the value gets a little bit subjective and so your clients, as taxpayers, simply have to make a good faith effort.

“Work with your accountant, do your best to determine what from the market has data,” says Waltman.

“Understanding the tax treatment for gas fees is very important,” Waltman says.

Gas fees happen upon purchasing an NFT. Any time a buyer purchases an NFT, they will likely incur a gas fee unless the NFT creator has waived the gas fee for or reduced the gas fee amount. Known for being steep (on Ethereum, in particular), gas fees can run upwards of $200.

“That expense that you incur, think of it like a transaction fee,” Waltman says. “You will add the gas fee amount to your cost basis in the NFT. And so your cost basis becomes the purchase price of the NFT plus any gas fees or other transaction fees that you’ve incurred.”

An NFT’s cost basis is important because if your client later decides to resell the NFT, the gain amount is going to be decreased. For instance, if they purchased an NFT for $1,000 and sold it for $2,000, the gain would be $1,000. But adding a $200 gas fee to a $1,000 purchase puts the cost basis actually at $1,200. So the gain is only $800.

“That reduces the tax that you’ll pay later when you resell,” Waltman explains.

Tax best practices are just as important for NFT collectors – if not more so.

“Understand what your tax position is before the end of the year,” advises Waltman. “Right now in December, before the year ends, you want to have an understanding of what your tax position is and your capital gains amount, because then you still have a couple of weeks to make some decisions if you need to do any tax loss harvesting or make charitable donations or contribute to retirement.”

Tell your clients to not wait until Jan. 1 rolls around to print their forms from CoinTracker or another platform. By then, it will be too late for them to offset or prepare for large capital gains because they weren’t fully aware of the tax implications of NFTs.

“That’s the situation we don’t want to see people in,” Waltman ways.