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 Rodin 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 smooth love potion (SLP), an ERC-20 token that players earn as rewards 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.
Nonetheless, 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 events—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 incur taxation.
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 purchase an Axie. At the time of the trade, if the ETH you used is worth more than it was worth when you received it, you have realized a capital gain. This value differential must be reported as such on a 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 it.
Selling AXS or SLP on an Exchange
It is a capital gain to make a profit by selling or otherwise disposing of AXS or SLP when its value is higher than it was when you received it. These earnings should be reported on Form 8949 of your tax returns.
Receiving an Axie or Other Item As a Gift
Following the IRS’s guidance on airdrops, if another player gives you an axie or another in-game item, you will owe regular income tax on the received gift.
To breed axies, a player must spend AXS and SLP. This is a taxable spend; you must pay capital gains taxes on any increase in value in the AXS and SLP from the time you earned it to the time you spent it. Receiving your newly bred axie in your wallet is likely treated like an airdrop and taxed as regular income. You should report a fair market value (FMV) for the newly bred Axie on your Schedule 1. We’ll discuss how to find the FMV in the next section.
To avoid hyperinflation, axies can only be bred a maximum of 7 times. Each time they mate, they also lose a portion of their value in ETH.
For example, say Axie “XYZ” was worth .5 ETH before it had ever been bred. After using “XYZ” to breed four times, it could be worth only .3 ETH.
What is this devaluation considered from a tax perspective? It is likely an unrealized loss; the asset has decreased in value, but that loss will not be realized until the asset is sold or otherwise disposed of. A capital loss will only be reported on your taxes when you dispose of the axie.
Determining Fair Market Value of a Newly Bred Axie
There are two approaches for determining the FMV of a newly bred axie.
You could report its cost basis as $0 and defer taxation until the asset is sold or disposed of. However, this approach may not withstand the IRS’s scrutiny in the event of an audit; the agency could argue you benefited financially from receiving the axie and thus under-reported your earnings at the time it was bred.
A safer approach is to calculate a FMV based on the selling price of similar axies at the time your axie was bred. Each axie has a class, stats, body parts, and abilities. By finding several axies whose attributes are similar to the one you bred, you can estimate a FMV.
If you use this method, it is important to keep records of the axies you used to make your estimate. Make sure your records include the date the axie was bred, the date you made your audit of the Marketplace, the price and attributes of the similar axies, and the price of ETH on the day of your estimate.
Are Axies Collectibles?
Axie creatures and in-game tokenized items could likely be considered collectibles. If so, they would receive a higher long-term capital gains tax rate (maximum 28%) when held over a year.
Although trading cards are not specifically mentioned by the IRS in their discussion of collectibles, they have historically been taxed as such. This suggests that NFT creature “cards,” like Axies or CryptoKitties could also receive the collectibles rate.
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