Non-Fungible Tokens (NFT) & The IRS
The world is changing constantly. A new item, investment or thing makes its appearance in our modern world, and it's called the Non-Fungible Token or NFT. When you are dealing in the world of NFTs, you will typically fall into one of two categories: a creator or an investor/trader.
YOU NEED TO KNOW THE NFT TAXATION CONSIDERATIONS
The IRS has not issued any NFT specific tax guidance yet. However, NFTs are likely treated as “collectibles” under tax code Section 408(m)(2). Although not specifically defined, according to the Section 408(m)(2)(A) “any work of art” is considered a collectible.
Be mindful “collectibles” are treated as capital assets for investors but have a higher tax rate than stocks or other securities. Think collectible art, cars, etc. with long-term rates of 28% versus 15% or 20%.
NFT taxation depends on how you are involved with them. Are you someone who creates and sells NFTs or are you buying and selling NFTs as an investor?
What’s the difference? Simply put:
NFT “creators are subject to ordinary income taxes and self-employment taxes on the proceeds they receive on the sale of the NFT reduced by any related expenses they might incur in the NFT creation. Think “sole proprietorship” and Schedule C on your personal income tax return.
Creators are the artists who create NFTs and offer them for sale in marketplaces like SuperRare and Nifty Gateway. Creators encounter a taxable event when they sell NFTs. As an example: Joe created an NFT item and sells it for cryptocurrency valued at $3,500. He would report $3,500 as ordinary income plus self-employment taxes if performed as an individual taxpayer.
NFT “investors” are subject to capital gains tax rates when they are acquiring and selling NFTs. This is a fairly speculative activity but they aren’t creating the NFT. They are simply buying and selling with the objective of making a profit.
Since NFTs are typically purchased with cryptocurrencies such as BitCoin or Ethereum, you may incur two taxable events.
Purchasing a NFT using Ethereum triggers a taxable event because you are disposing of a cryptocurrency, which is treated as a property [IRS Notice 2014-21]. This is similar to trading shares of Microsoft to buy shares or Google or Apple. It creates a taxable event.
So, if you have a profit embedded in the crypto that you use to acquire the NFT, that creates a taxable gain. Selling the NFT later creates a second taxable event.
Since NFTs are likely considered “collectibles” as explained earlier, it exposes high income earners (single filers with over $441,450 of taxable income and married filers with over $496,000 of taxable income) to a 28% tax rate on collectible gains vs. the highest 20% tax rate on regular cryptocurrency and stock long-term capital gains. High income earners will also have to pay the 3.8% net investment income tax in addition to the highest 28% tax rate on collectibles.
Steven Miller, CPA | 06/15/2021