Axie Infinity Taxes: What You Need to Know
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Most transactions on the NFT game Axie Infinity are probably taxable.
If you are playing Axie Infinity as a business, you can deduct certain costs as expenses.
What is Axie Infinity?
Axie Infinity, the Vietnamese non-fungible token (NFT)-based crypto game, is surging—both in popularity and profitability. Built on the Ronin sidechain of Ethereum, Axie Infinity is a gaming universe
in which players buy, breed, train, and battle NFT creatures called Axies. These creatures’ values begin at around $300, although the rarest Mystic Axies can sell for over $1 m.
In addition to its native governance token—Axie Infinity Shards (AXS)—the platform has in-game currencies. Most notable is the smooth love potion (SLP), an ERC-20 token that players earn as a reward for victories in battle. SLP is used to breed new NFT creatures and can also be purchased on the open market.
Earning from Axie Infinity does have barriers to entry, however. The game has a “play to earn” structure; a player must own three Axies to play the game. In other words, a user must have spent a fair amount of ETH inside the game before being able to earn SLP.
Players can get around this financial roadblock, however. The Axie universe supports "scholarships," or agreements in which "scholars" can borrow Axies from "managers" and use the borrowed Axies for battle.
Although any battle income earned would be paid to the manager's wallet, under the terms of a scholarship, the manager would then distribute a portion to the scholar. Scholarships are mutually beneficial; the scholar gets to earn SLP without owning three Axies, and the manager gets to passively earn SLP from excess Axies they cannot battle because of account restrictions.
As such, Axie Infinity has attracted hundreds of thousands of users, including a large number from the developing world. For many of these players, Axie Infinity provided an alternative source of income during COVID-19.
Taxable Events in Axie Infinity
With real profits being made on Axie Infinity, questions have started to emerge about Axie Infinity taxes: Should income be reported on income taxes? If so, how?
The short answer is this: most transactions made on Axie Infinity are probably taxable—even if your AXS, SLP, and NFTs never leave the Axie universe. The IRS considers any crypto-to-crypto transaction a taxable event. Since most assets in Axie Infinity are tokenized, even seemingly non-transactional actions like using potions or breeding new creatures may result in taxes. You should report them on your NFT tax software.
Below, we outline how some Axie Infinity transactions would be taxed in the U.S.:
Purchasing an Axie
To get started in the game, a player must use ETH to buy an Axie. At the time of the trade, if the ETH you used is worth more than what you paid for it, you have realized a capital gain. This must be reported on Form 8949.
Selling an Axie
If you sell an Axie in the Axie Marketplace for a profit, you have realized a capital gain. You must report any increase between the Axie’s cost basis and its selling price on your crypto taxes.
SLP earned from battling Axies would be considered regular income. You should report this income as the market value of the SLP on the day you earned or claimed it based on your tax professional’s advice.
Selling AXS or SLP on an Exchange
Making a profit by selling or disposing of AXP or SLP is considered a capital gain when its value is higher than it was when you received it. US taxpayers should report these earnings on your crypto Form 8949.
Receiving an Axie or Other Item As a Gift
Following the IRS’s airdrops guidance, if another player gives you an Axie or another in-game item, you will owe regular income tax on the gift. The amount of income you should report is the fair market value (FMV) of the Axie on the date you received it.
Manager Payouts and Winnings Distributions
All winnings are paid out to the manager, so the manager owes income tax on all profits made from their scholar's victory. However, when the manager sends a portion of the winnings to the scholar, they may deduct some or all of that amount, depending on whether they consider Axie Infinity to be their business or their hobby.
When the manager sends the scholar the agreed-upon portion of the winnings, the scholar also experiences a taxable event and has to pay income tax on their fraction of the payout.
To breed Axies, a player must spend AXS and SLP. This is a taxable spend, and as such you need to pay capital gains taxes on any value increase in the AXS and SLP from the time you earned it to the time you spent it.
These breeding costs could potentially be considered transaction fees. If you and your crypto tax advisor choose to interpret them as such, you may be able to deduct some or all of these expenses.
Much of an Axie’s value is based on its specific “genetic” traits. However, a portion of its worth is also based on its breeding potential. Each Axie can only be bred seven times, and each time it is bred, its breeding price increases.
Receiving a new Axie in your wallet is likely taxed as a regular crypto-to-crypto transaction and reported on your Schedule D. However, how to determine the cost basis of a newly bred Axie is not clear; the IRS has not issued any guidance on Axie breeding. In the next section, we will discuss a possible method.
Determining the Cost Basis of an Axie
Based on our understanding of the breeding process, we think one possible tax treatment for setting the cost basis of an Axie is to report it as the combined breeding cost (AXS + SLP) of its parents plus an additional sum to account for each parents’ loss of breeding potential. To calculate the correct value to report, we recommend speaking to a crypto tax professional.
Pros and Cons of Playing Axie Infinity as a Business
Axie Infinity as a Business
If you play Axie Infinity as a business, your NFT creatures may be treated as inventory. In this case, any profit made from selling or trading them would not given favorable capital gains crypto tax rates. Instead, it would be reported as regular self-employment income.
However, you will generally be able to deduct more expenses than you would if you treated your gameplay as a hobby. You could potentially deduct all of your breeding fees and scholar payments, provided your tax advisor approves of the strategy.
Axie Infinity as a Hobby
If you play Axie Infinity as a hobby, you may use the favorable capital gains crypto tax rate on the profits made from selling or trading your NFT creatures. This means that you could also report crypto losses to offset capital gains earned elsewhere or up to $3,000 of your income.
However, the amount of expenses you can deduct is limited. The Trump administration's Tax Cuts and Jobs Act eliminated most personal miscellaneous itemized deductions until 2025.
Frequently asked questions about Axie Infinity taxes
Here are answers to frequently asked questions about taxes and Axie Infinity.
Is playing Axie Infinity taxable, and why?
Yes, playing Axie Infinity can be taxable. The IRS considers most in-game transactions, like buying and selling Axies, earning in-game currency (SLP), and even breeding, as taxable events. This means you may need to report them for tax purposes.
What are the main taxable events in Axie Infinity that players should be aware of?
The main taxable events in Axie Infinity include purchasing Axies with ETH (potentially resulting in capital gains), selling Axies for a profit, earning SLP from battles (considered regular income), selling AXS or SLP for a profit, and receiving Axies or other items as gifts (subject to income tax).
How can I determine the cost basis of my Axies, especially those obtained through breeding?
Calculating the cost basis of bred Axies can be tricky, but one approach is to consider the combined breeding cost (AXS + SLP) of their parents plus an additional amount to account for the parents' loss of breeding potential. It's advisable to consult a crypto tax professional for accurate reporting.
What are the tax advantages and disadvantages of playing Axie Infinity as a business versus a hobby?
Playing Axie Infinity as a business may subject your NFT creatures to self-employment income tax rates. However, you can generally deduct more expenses, such as breeding fees and scholar payments. Playing as a hobby allows for capital gains tax rates on profits but limits deductible expenses due to tax law changes, so it's important to choose your approach wisely based on your financial strategy.
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Last reviewed by Zac McClure,MBA on November 15, 2023 · Sources