Gifting Non-Fungible Tokens – Problems And Predictions

           Much of estate planning is driven by the desire to benefit others, whether a charity, a family or an individual. Benefiting another involves making a gift, either during your lifetime or at your death. Additionally, tax planning strategies can leverage the gift to reduce or eliminate the transfer taxes due when you make either a lifetime or testamentary gift. Since they are so new, blockchain cryptocurrency in general and Non-Fungible Tokens (NFTs) in particular are surrounded by uncertainty when you plan to make gifts of these digital assets.

           How to Gift NFTs – the Basics

           To gift an NFT, you need to acquire an NFT. As NFTs are not fungible, they cannot be traded like cryptocurrencies.  This means you will need to either create an NFT and upload it to a marketplace, or go to the marketplace and buy an NFT. Now, the most popular currency for buying NFTs is Ethereum; and, you will need to follow the procedure for buying the Ethereum and depositing it into a virtual wallet. Once you own Ethereum, you can buy NFTs at marketplaces like OpenSea or Rarible, or you can go to specific brands, like the NBA, and buy NFTs directly from them. 

           Once you own and NFT, you will need enough Ethereum to pay the transaction fees as well as the recipient’s Public Wallet Address. It is critical that you have the correct Public Wallet Address since once sent the NFT cannot be recovered if it is sent to the wrong address. Next, open your wallet by logging in and make sure you have enough Ethereum to cover the transaction costs (AKA gas fees). From there find the NFT you want to send and choose the option to send the NFT to another wallet. Enter the recipient’s wallet address and the software will confirm that their wallet is compatible – that is you can only send an Ethereum NFT to a wallet compatible with Ethereum so you cannot send it to, say, a Bitcoin wallet. 

           When you send the NFT, you have a choice how much “gas fees” you wish to spend. A faster transaction costs more, a slower transaction costs less, but the transaction may be very slow indeed. Again, there is no “do-over” for sending an NFT, so double and triple check the details to ensure that you are sending the right NFT to the right wallet. Once you click to send the NFT, it is sent out to the network of computers that are the blockchain. Because the blockchain is public, you can view your transaction while it is in progress and confirm the NFT has landed and which wallet it lands in when the transaction is complete. Since not all wallets notify their owners of a transaction, you should also confirm the transfer with the recipient.

           There are other ways of transferring an NFT, one way is to load the NFT onto a wallet on a USB stick (a so-called cold wallet) and give them the physical hardware and the keys to access the wallet. Ledger wallets are inexpensive and come with NFT support as well. 

           Gifting NFTs is more Complicated than That.

           Seems simple enough, but there are complicating factors. The first is taxes. Whenever you gift something, you have the potential for transfer taxes, gift taxes for lifetime gifts and estate taxes for testamentary gifts. Those taxes are based on what the fair market value of the gift is at the time of the gift. I have discussed some the issues facing the valuation of NFTs previously, so I will not go into the details here.  Suffice it to say that the actual methodology for valuation of an NFT is uncertain at the best of times, and nearly impossible when you consider the various forms of ownership you might have in an NFT: everything from the right to receive a percentage of the sale proceeds in the future to a “shard” of a fractionalized NFT .

           The second complicating factor is asset protection. Although you might be able to manage your NFT portfolio, the beneficiary of your gift may not – either due to their age, their experience or their interest in the digital assets. When you gift an NFT to someone outright, there is no way that you can separate the management of the NFT, including when to hold, buy or sell NFTs, from the beneficial ownership. 

           NFT Gifts using Trusts

           The complications of taxes and asset protection involved in any gift of property can be offset by using Trusts. Trusts are very flexible when it comes to holding property, such as real estate, artwork and now, cryptocurrency. Trusts can be used to defer or avoid paying both gift and income taxes on the gift. There are specific terms that can be drafted into trust to better handle digital assets, but there are many issues that the grantor of the trust, and the trustee of the trust, still have no answer to. These include:

• How closely will the IRS follow the rules laid down for gifting Art and other tangible property?
• What global national and local regulations will apply to these “borderless” digital assets?
• How can beneficiaries and grantors protect themselves by having the Trustee covered by E & O insurance, when the market is so uncertain?
• How can a Trust safeguard digital assets and act as a prudent investor when the market is both unregulated, unpredictable and open to fraud and theft through hacking?
• How will federal securities laws apply to NFTs as an alternative investment?

Each of these points, and many others, lead to other complicated issues, which will not be solved until the solution is tested in real life.

My forecast of the Near Future on gifting NFTs:

• The IRS will follow the broad outlines of the regulations on gifting Art so long as Cryptocurrency in general and NFTs in particular are treated as property for tax purposes. 
• Global conventions, either state sponsored or by the giant tech platforms, will provide some rationality over the conflicting global, national and local regulations.
• Trustees and trust companies that specialize in digital assets will develop independently of the institutional trust companies and will provide the necessary flexibility and protection for clients so that their digital assets can be held by  the Trustee of any NFT when it is received by the Trust .
• Trusts will be specially drafted to provide some safeguards, and independent trustees will work to negotiate with digital asset management firms to provide as much protection as possible, including the use of “hot” and “cold” wallets.
• The SEC will not automatically consider NFTs an alternative investment by itself, though it will regulate those companies (including some trusts) which hold themselves out as a register investment company rather than as a fiduciary.

How good are my predictions? Probably no better or worse than anyone else in the industry today. What will happen is that those who dare to strike out into the unknown may very well end up defining what role trusts will play in the taxation and asset protection of digital assets, both by their successes and their failures. Now more than ever is the time to know how to plan in uncertain times.