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 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.
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 income earned from winning would be paid out to the manager's wallet, under the terms of a scholarship, the manager would then distribute a portion of the winnings 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 has 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 result in 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 or claimed it, based on your tax professional’s advice.
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.
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. 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
Because all winnings are paid out to the manager, the manager incurs income tax liability for all profits made from their scholar's victory in battle. 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; 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.
These breeding costs could potentially be considered transaction fees. If you and your 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 7 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.
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.
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 tax rates. Instead, it would reported as regular income.
However, you will generally be able to deduct expenses to a greater degree than you would if you treated your game play 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 tax rate (or very likely the collectible gains tax rate) on the profits made from selling or trading your NFT creatures. This means that you could also use capital 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.
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