An Update on NFTs – Non-fungible Tokens
“An Update on NFTs, Non-Fungible Tokens,” that’s the subject of today’s ACTEC Trust and Estate Talk.
This is Stacy Singer, an ACTEC Fellow from Chicago, Illinois. In August we shared a podcast that explained the basics of a non-fungible token, a relatively new type of digital asset. Today, ACTEC Fellow, Professor Gerry Beyer, of Lubbock, Texas will tell us more about NFTs, including how they are created and purchased. Welcome, Gerry.
Understanding an NFT
Thank you. It’s great to be back to provide you with an update on non-fungible tokens or NFTs. As you may remember from the first podcast, an NFT is a digital file stored on the block chain in the same manner as cryptocurrency, like Bitcoin. However, unlike cryptocurrency, which is analogous to money, NFTs represent digital files such as pictures, photographs, music, and videos. You can think of NFTs like collectables, autographed items, baseball cards, stamps, coins and artwork.
The creating, buying, and selling of NFTs have continued to grow in popularity. Last time we discussed the most valuable NFT, Everydays: the First 5,000 Days, which sold at auction for almost $70 million. Here are some other recent NFTs: The swag bag at the recent Oscars included an NFT of Chadwick Bosman, the actor who portrayed the hero Black Panther. Jack Dorsey’s first tweet – remember Jack Dorsey was the cofounder of Twitter, his first tweet sold for $2.9 million. And a New York Times article that just discussed NFTs sold for $0.5 million. I wonder if I made an NFT of this podcast that I could get that kind of money.
Asset Protections and Management Considerations
Accordingly, it is important for us to revisit and expand on how to deal with NFTs when planning and administering an estate. The first thing you must do, it is essential to determine if your client owns or intends to purchase NFTs. So, please include a question about NFTs in your client intake questionnaire or during your first interview. If you don’t know your client owns NFTs, you won’t be able to plan for them properly.
Let’s now look at handling NFTs during the client’s lifetime. The client must keep careful records of the price paid for each NFT and the price sold so that the correct amount of capital gain, or capital loss, is reported for tax purposes. And there can be an issue here because many clients will be purchasing NFTs with cryptocurrency, and that leads to additional concerns because cryptocurrency is property, not money. Thus, if cryptocurrency is used to purchase an NFT, that purchase transaction will cause a capital gain or loss based upon the price the client paid for the crypto that was used to purchase the NFT. You could see that there could be significant accounting issues here.
The client might also want to consider holding the NFT in an entity rather than personally. Many people are suggesting the use of a limited liability company because there are many potential advantages to an LLC. The owners of an LLC can transfer LLC interest easier than transferring the NFT itself, which requires another Blockchain transaction. Transfer tax discounts may be possible as the interest in the LLC may be minority in nature, or there may be a lack of marketability. And other normal benefits of LLCs may also be available such as asset protection.
The client must protect the private key and seed phrase to access the NFT because there is no recover password option if the password or seed phrase is forgotten or lost. So, there should be several secure copies of the password or seed phrase in a safe deposit box. Or, what some people do is they actually have it engraved in a metal plate and put somewhere safe so it can survive a fire, flood, earthquake, tornado, or hurricane. You might also want to divide the seed phrase and give it to different people. So that only if all the people get together with the seed phrase can the NFT be accessed. It’s like bringing the infinity stones back together.
NFTs in a Will and After Death
Now that we’ve looked at handling NFTs during the client’s lifetime, what about a death? Well, you have to determine whom the client wishes to own the NFTs after death. The client’s will can make a specific gift of the NFT, otherwise they will just pass under the residual clause of the will. And as during lifetime, be sure there are records of the price paid for capital gains purposes, especially if Congress repeals the carry over basis rules. Also, as during lifetime, be sure to have a mechanism in place to transfer the password or seed phrase to the beneficiary. Because if you do not, the NFT and its value will be lost forever.
Let’s look at NFTs as a trust investment. Do they make a good trust investment? Probably not. They don’t satisfy the prudent investor standard because their value are too volatile. However, some clients may want to hold NFTs in a trust or even allow the trustee to purchase NFTs. And that can be done, you just need to be certain that the trust contains express language, where the settlor gives express permission to the trustee to do investing in NFTs or retain them in the trust even though they may otherwise violate the prudent investor standard.
Creating an NFT
Now, the last thing we want to talk about is creating an NFT. Now, I’ve been speaking about NFTs for quite a while, but I had never owned one or created one. So, I kind of felt like a marriage counselor who gives advice on marriage, but who’s never been married. So, I figured it was time to create one myself. Now, the creating process is called minting- minting the NFT. And here’s the summary of the process which turns out to be not as a difficult as you might think.
Well, the first thing you want to do is locate a website or app for your phone that streamlines the NFT minting process. You don’t want to try to do all the behind-the-scenes work. That would just be tremendously complex. You find some site that will do it for you. I even found a site that you create an NFT at absolutely no charge. However, when purchasers go to buy the NFT, they’re going to have to pay a fee, which is called gas, to provide the funds needed to keep the Blockchain in operation.
All right. So, you find one of these accounts, these websites, that will allow you to create the NFT, and then you create a regular account, username, password, email, such things as that. And then you install an extension on your web browser or phone app to access your digital asset wallet. That is where your cryptocurrency is stored. Now, maybe you don’t have any cryptocurrency. You don’t have a digital asset wallet. Then most sites will give you a link where you can create a wallet and the instructions were very easy. And when you do it, you’re going to get one of these incredibly long passwords or seed phrases.
Now, in my case the seed phrase is twelve English words that have absolutely no logical connection to each other. Now, I’m not going to give them to you, but it’s something like this: road, dinosaur, pumpkin, dirt, and it just goes on. And that’s the seed phrase that you would need to access the wallet where the cryptocurrency and now the NFTs are stored. Once you’ve done that, you can now create the NFT. Like I said, that’s called minting and, all you do is upload a digital file- a song, a video, a picture, or whatever file you want- and it gets turned into an NFT by the site. You could just use any photo which is on your computer or phone as an example.
Once you create the NFT, you then determine what you want to do with it. You can just keep it in your wallet like you say I created it and I own it and I have it. It’s in my wallet. Or, you can transfer it to anybody you would like to. Or, you could put it up for sale. You can put it up for sale at a fixed price or at an auction where you provide some sort of starting bid. And that’s all that’s to it. Now you’re an owner and a creator of an NFT and, if you want, you can be selling it as well.
So, to wrap up, I hope our discussion today has expanded your knowledge of NFTs, how to advise your clients, and hopefully have motivated you to mint your own NFT.
Thank you, Gerry, for bringing us up to speed on NFTs and estate planning.
You may be interested in these podcasts:
- Non-Fungible Tokens: What Every Estate Planner Needs to Know
- Cryptocurrency Regulation and Qualified Custody
- The Future is Here: Dealing with Bitcoins and Cryptocurrencies in Tax and Estate Planning
- The Valuation and Reporting of Cryptocurrency on Income, Gift, and Estate Tax Returns
- Digital Asset Management in Life and Death
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