Dividing Digital Wealth: NFT Capital Losses in Family Law Property Settlements
Once clogging up the Ethereum network for being traded at such high volumes, non-fungible tokens (or “NFTs”) have lost the hype that came along with trying to invest in these unique, limited production, and highly speculative investment products. According to a September 2023 study examining over 73,000 NFT collections, a staggering 95% are valued at 0 ETH, rendering them essentially valueless. What is now being referred to as “Crypto Winter”, this shift has raised important questions about capital property losses, especially in the volatile realm of NFT investments. In the blog that follows, we’ll delve further into this complex terrain, focusing on the intricate dynamics of dividing family property when NFTs are involved. We'll also explore the nuances of capital losses, and the importance of diligent record-keeping and professional legal and tax guidance in navigating NFT valuation.
NFTs and Family Property Division
Generally, under the Alberta Family Property Act, when spouses or adult interdependent partners separate, their property is presumed to be divided 50-50. The aim is to balance out their total property value for a fair division. This can include various types of assets and debts such as real estate, investments, mortgages, and even NFTs. In some cases, the equalization of property will result in one person owing money to the other to balance the property value between them – this is commonly referred to as an “equalization payment”. In these instances, the equalization of family property might also adjust for taxes one partner may owe because of that equalization payment. For example, if one spouse owes taxes on a property they are dividing, this could affect the 50-50 split. The division can also consider tax benefits one spouse might get from selling or disposing of an asset, even at a loss that results in an ongoing tax advantage.
Family property is subject to changes in value, whether through passive appreciation (market forces) or active efforts of the spouses, and that appreciation is a relevant consideration when calculating the parties’ net divisible property. In this context, market appreciation refers to the increase in the value of capital assets over time, which is often influenced by economic conditions such as inflation. But what happens when those long-term investments drastically plummet in value, resulting in a tax benefit to a party? Is there a tax benefit to one of the spouses?
When Are NFTs Capital Property
In Alberta, family property is valued at the date of trial, not the date of separation as per the ruling in Hodgson v Hodgson, 2005 ABCA 13. Accordingly, there may be asset valuation disputes as to the timing of “realized” gains or losses, and whether they were accrued during the parties’ relationship. Generally, if a spouse were to purchase NFTs with the intention of selling them for a profit, it is possible that any gains or losses from these transactions may be treated as capital gains or losses.
Capital Losses of NFTs
Capital property losses incurred by trading NFTs in Canada are subject to the same general principles as other capital property losses, as outlined in the Income Tax Act, so long as they are held for investment purposes rather than for business. However, NFTs present unique challenges and considerations due to their relatively new and digital nature.
Calculating and Record Keeping
Capital losses from trading NFTs are calculated by taking the difference between sale price of the NFT on the blockchain and any transaction fees, commissions, or other acquisition costs. For these reasons, it’s crucial to maintain detailed records of NFT transactions, including purchase and sale dates, amounts, and any associated costs. This documentation will be essential when calculating capital gains or losses for tax purposes, and CRA will likely request such supporting documentation.
Why Are Capital Losses Relevant
Recall that in Alberta, the parties are required to equalize their net property, which accounts for deductions in certain circumstances as provided by the Family Property Act. It may also require the unequal division of family property to ensure a just and equitable division between the parties.
Capital losses from NFT trading may be used to offset any capital gains. On the other hand, if one spouse has experienced a capital loss upon the disposition of any NFTs, or other speculative investments, that loss may be a personal tax benefit. The Income Tax Act does not contemplate a “taxable household”, which means one party may have a tax advantage that the other cannot take benefit from. As such, one party may be unfairly advantaged by being able to carry a capital loss accrued during the parties’ relationship into subsequent years post-separation, while the other party gets no tax benefit despite being entitled to half of the property that was disposed of.
Therefore, any capital losses accrued during the parties’ marriage or adult interdependent relationship, should be considered to ensure a just and equitable division of property. This may even result in an increased amount of property to the recipient spouse.
Complexities
Due to the digital and evolving nature of NFTs, there may be specific challenges and considerations that spouses should be aware of. From a tax perspective, proper record-keeping and compliance with tax reporting requirements are essential to ensure that capital losses from NFT trading are appropriately accounted for in dividing family property. Consulting with a tax professional can help navigate the complexities of NFT taxation effectively. From a legal perspective, understanding how, when, and what property is divisible, and calculating the net equalization of the divisible property can be a daunting task, requiring legal professional assistance.
Given the evolving nature of NFTs and their unique tax implications, it's advisable to seek professional tax and legal advice when trading NFTs, especially if you are actively engaged in NFT trading or as a business. By working with knowledgeable family lawyers experienced in handling digital assets, like the team at Crossroads Law, couples can address any legal complexities that may arise and make informed decisions about the division of their cryptocurrency and NFT holdings. The lawyers at Crossroads Law are ready to help you with your case today. Get started by booking your free 20-minute consultation online or by phone.
