Using leverage to buy NFTs creates two tax obligations: tracking capital gains on the NFTs and deducting interest on the loan.
Most traders report the gains but forget the interest deduction, leaving thousands in tax savings unclaimed.
The Two Tax Items
1. Capital gains/losses when you sell the NFT 2. Investment interest deduction for the loan interest you paid
These are reported on different parts of your tax return and follow different rules.
Capital Gains Calculation
The loan itself doesn’t affect your cost basis or proceeds.
You borrowed 10 ETH at $1,500 per ETH ($15,000) and bought a Mutant Ape. Six months later, you sold it for 12 ETH at $1,600 per ETH ($19,200).
- Cost basis: $15,000 (what you paid)
- Proceeds: $19,200 (what you received)
- Capital gain: $4,200
The fact that you borrowed the money to buy it doesn’t change this calculation. You repaying the loan later isn’t relevant to the gain calculation.
Interest Deduction
The interest you paid on the loan is separately deductible as “investment interest expense” on Schedule A.
You borrowed 10 ETH in DeFi at 8% APR. You held the loan for 6 months before repaying.
Interest paid: 10 ETH × 8% × 0.5 years = 0.4 ETH (worth $640 at the time you paid it).
This $640 is deductible as investment interest, but only up to your net investment income for the year.
The Investment Income Limit
You can only deduct investment interest up to your total investment income (capital gains, dividends, interest received).
If you had:
- $4,200 capital gain from the NFT sale (above)
- $1,800 in other capital gains
- Total investment income: $6,000
Your $640 interest expense is fully deductible because $640 < $6,000.
But if you only had $400 of investment income total, you could only deduct $400 this year. The remaining $240 carries forward to next year.
NFTfi and BendDAO Interest
Interest you pay on NFT-backed loans is also deductible.
You deposited a Bored Ape on NFTfi and borrowed 20 ETH at 15% APR. You held the loan for 3 months.
Interest paid: 20 ETH × 15% × 0.25 years = 0.75 ETH (worth $1,125).
If you used the borrowed funds for investment purposes (buying more NFTs, crypto, stocks), the $1,125 is deductible.
If you used the funds for personal expenses (rent, vacation, paying off credit cards), it’s NOT deductible. Investment interest only applies when you use the proceeds for investing.
Liquidation Scenarios
If your collateral got liquidated and you lost your NFT, you have:
- Capital loss on the NFT (cost basis minus liquidation proceeds)
- Interest deduction for interest paid before liquidation
Both are deductible, but the capital loss goes on Schedule D and the interest goes on Schedule A.
Example: Borrowed 15 ETH against your Azuki (cost basis $20,000). Paid $800 in interest over 4 months. Floor crashed, you got liquidated.
- Capital loss: $20,000 (basis) - $0 (you received nothing) = $20,000 loss
- Interest deduction: $800
These stack—you get both tax benefits.
Documentation Needed
Save these records for leveraged NFT purchases:
- Loan agreement or transaction showing borrowed amount
- Interest payments (transaction hashes, protocol statements)
- Proof you used funds for investment (wallet trail showing borrowed ETH → NFT purchase)
- NFT purchase and sale transactions
If you can’t prove you used the borrowed funds to buy investments, the IRS can disallow the interest deduction.
Action Step
Review all NFT-backed loans and leverage you used this year. Calculate total interest paid. Check if you used the proceeds for investments (deductible) or personal use (not deductible).
Add the deductible interest to your Schedule A. If you itemize deductions, this reduces your tax bill.
Missing the interest deduction means you’re paying tax on gains without claiming the offsetting costs. That’s leaving money on the table—sometimes thousands of dollars.