It has been seen time and time again that certain products, services, and other income streams develop in the U.S. before the IRS and Congress put tax provisions on them. This has been the case over the last few years with cryptocurrency, and now more recently there has been increased movement related to NFTs (Non-Fungible Tokens). As NFTs have increased in popularity to the point of becoming a multi-million dollar industry, there comes some tax uncertainty related to them.
Intro to NFTs
Cryptocurrency and NFTs may seem so similar due to their blockchain technology, and the fact that they are stored on a digital ledger; however, NFTs are non-fungible while cryptocurrency is fungible. To make this clear fungible means that something can be replaced by another identical item, and while you can purchase another bitcoin, you cannot purchase another piece of art (NFT).
What does this Mean
While the IRS has increased its guidance on cryptocurrency, there is still a lot of grey area when it comes to NFT reporting requirements. This being said, the tax treatment of intangible assets and virtual currency are the best indicators of how NFT transactions should be handled in the present. Let’s take a look at what this means in terms of tax:
Creators:
An NFT could be an original piece of art or a digital version of an existing physical asset. Typically the creation of an asset alone is not a taxable event, rather the taxable event is generated upon selling the asset. This holds true for the creation of a digital asset with the sale price counting as ordinary income; the tricky part comes when determining the basis of an NFT. If the piece is an original this will likely not be a problem, but when creating a digital duplicate of a preexisting asset how is this determined? Is it a completely separate asset or does it derive some sort of basis from its related property?
On top of this issue for creators, they also face some expenses that could affect their tax liability. A major factor is fees coming from auction houses where the asset is being sold. On top of this, there is sometimes a “Gas fee” required when trading the Ethereum blockchain. How should these fees be accounted for?
Purchasing:
There seem to be many different groups of people purchasing NFTs for a variety of reasons; these different reasons could potentially have different tax consequences! Currently, this is pooled into two groups, investors and collectors. Investors are generally considered to be purchasing an asset in hopes to make a financial gain, collectors are considered to be purchasing the item for personal enjoyment. In either case, the sale of an NFT would likely be subject to capital gains taxes. If the IRS considered an NFT to be “collectible” as defined by the tax law, the sale could be subject to the higher 28% capital gains tax rate on the sale.
Wrap Up:
While these are some of the key points being brought to light around NFTs today, there is still a lot to be covered, and uncovered! The IRS is likely to release more guidance and clarity relating to the tax effects of NFTs, but this may not be in time to help those out already involved in NFTs. For the time being it’s likely your best to collect all the data you have on your NFT transactions and submit it to your accountant for their help today.