Blockchain Technology: What Is the Current Status of the Tax Treatment of Cryptocurrencies and NFTs?

Blockchain technology has been making waves in the world of finance for some time now. It was only through this technological breakthrough that digital currencies—or cryptocurrencies—could be created. Bitcoin and other cryptocurrencies have been on the market for several years now and continue to enjoy growing popularity. Regarding the tax treatment of cryptocurrencies, there is at least one generally applicable tax regulation in place today. However, the possibilities of blockchain do not end with cryptocurrencies. The technology is regularly used for new ideas. One of the current innovations made possible by blockchain are so-called NFTs. Simply put, NFTs are a unique and non-fungible proof of ownership for digital assets. Trading in NFTs is fundamentally an issue that should be considered from a tax perspective. So far, however, the situation remains unclear. In this article, we would like to explain the tax-related specifics of cryptocurrencies and take a look at the current tax situation regarding NFTs.

What are cryptocurrencies?

Before we can examine how cryptocurrencies are treated for tax purposes, we should clarify what they are. Cryptocurrencies are digital currencies without a comprehensive government regulatory framework. Therefore, the term “currency” should not be misunderstood: Cryptocurrencies are not accepted as traditional currencies and differ from traditional currencies both legally and for tax purposes. The term “asset” is therefore much more appropriate when referring to cryptocurrencies. These assets exist solely in digital form and are managed using blockchain technology. The blockchain is a digital structure that stores all cryptocurrency transactions ever made, thereby making ownership of the digital currency traceable. Figuratively speaking, it is a digital ledger in which every single transaction is recorded in chronological order.

So far, the focus of cryptocurrencies has been on trading the digital “coins.” The value of cryptocurrencies is subject to constant fluctuation, which makes trading quite attractive (but risky). Buying and selling with the goal of maximizing profits is currently one of the most common reasons why people trade cryptocurrencies. In some cases, digital currencies can also be used to make purchases, though this is currently only possible in isolated instances.

How are cryptocurrencies treated for tax purposes?

Cryptocurrencies are generally traded to generate profits. This suggests that the tax authorities also have an interest in the trading of digital currencies. Crypto investors must therefore also consider tax implications. Trading in cryptocurrencies and profits derived from them are subject to taxation.

However, there are special considerations regarding taxes and cryptocurrencies. Digital currencies are not legal tender in Germany. Consequently, profits from trading cryptocurrencies cannot be compared to income from stocks, investments, or other financial transactions. Rather, profits from trading digital coins are comparable to income from the sale of art or alternative speculative assets. From a tax perspective, this can certainly be advantageous. Taxes do not always have to be paid.

Whether taxes are due on the sale of cryptocurrencies depends on the amount of the profit and how long the digital coins were previously held by the individual. Generally, profits up to an exemption limit of 600 euros are tax-free. If this limit is exceeded, the entire profit is subject to tax. However, significantly higher profits may also remain tax-free provided a certain holding period has been met. If the investor has held the sold coins for more than one year, no tax is due regardless of the amount of the profit. If the holding period is shorter and the 600-euro threshold is exceeded, profits are subject to taxation. Taxation is based on the individual’s personal income tax rate. It should also be noted, of course, that losses are also relevant for tax purposes and can reduce the tax burden or be offset against other gains.

Although there are still some uncertainties regarding the tax treatment of cryptocurrencies, the general approach is regulated. Investors can therefore rely on the established principles, with the exception of a few special cases. The situation is different for novel variants, such as NFTs. Here, the tax situation is still significantly more uncertain. Below, we would therefore like to draw a comparison and explain what is known so far.

What are NFTs?

The abbreviation NFT stands for Non-Fungible Token. These are unique “tokens” based on blockchain technology. Unlike Bitcoin, for example, they are not a currency but rather a type of unique certificate. NFTs are used to collect and trade virtual and unique goods or objects. What may seem difficult to understand at first becomes clearer with an example. NFTs are used particularly in relation to digital art and music. They are also frequently used for specific objects in video games. For example, a digital music track is offered and sold as a token. The buyer thereby acquires the rights to the music track. The whole process is reminiscent of the traditional transfer of copyrights. The difference is that all processes are digital, and ownership of the NFT is stored on the blockchain.

Since NFTs are still a relatively new phenomenon, it is not yet clear to what extent the tokens will establish themselves as an investment. However, works of art have already been auctioned using NFTs, with one sale fetching $60 million. NFTs therefore appear to have investment potential.

The Tax Treatment of NFTs

With the help of the blockchain, NFTs can be traded similarly to cryptocurrencies, which in turn allows for buying and selling with the potential to generate a profit. We thus find a situation similar to that of cryptocurrencies. NFTs may well be viewed as works of art or valuables, which would therefore need to be taxed like cryptocurrencies. However, there are currently no clear regulations regarding this matter from the tax authorities or tax law. The tax authorities have not yet commented on the matter, which makes NFTs a tax risk at this time. Are NFTs taxed like cryptocurrencies? Is there an alternative tax regulation? All these questions remain unresolved.

So what does this mean for you as an investor? Should you simply avoid buying NFTs altogether? We cannot, of course, make any recommendations at this point. Ultimately, the situation is simply too uncertain. From a tax law perspective, however, it is important that you protect yourself as best as possible. This starts with keeping all records of your trading activities so you can provide evidence if the tax office requests it later. Furthermore, it might seem tempting to take advantage of the lack of regulations and omit reporting this income on your tax return. As experienced tax advisors, however, we strongly advise against this approach! Even though there are no specific regulations at this time, it makes sense to report the gains or losses from NFT trading on your tax return and thus fulfill your obligations as a taxpayer. It remains to be seen what the respective tax office will ultimately make of the information provided. As a taxpayer, however, you will at least have fulfilled all due diligence obligations.

Tax Consulting in Düsseldorf and Oberhausen

We hope you enjoyed this post. The world of blockchain and the opportunities it presents will likely continue to shape tax law in the future. It is therefore worthwhile to keep an eye on tax developments on a regular basis. There is a great deal of work in this regard, particularly for the tax authorities. We are currently seeing the legal loopholes in the example of NFTs. In conclusion, it can be stated that investing in novel forms of investment always comes with specific tax implications. It therefore makes sense to always consult a tax advisor before trading in any such assets. Comprehensive advice is particularly important for high-value investments.

At Trimborn . Partner, we handle your tax matters. Our team of qualified professionals is happy to assist you and is always up to date. Trust in our experience as tax advisors. Contact us to schedule a consultation. You can find our offices in Düsseldorf and Oberhausen.