The Essential NFT Tax Guide for Creators and Investors
NFTs have exploded in popularity among investors, artists, and gamers. But do you know how they're taxed? Learn more.
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For investors, most NFT transactions are taxable as capital gains or losses.
However for creators and/or dealers, many NFT transactions may be considered self-employment income.
From Kings of Leon to NBA Topshots to digital artists like Beeple and Pak, popular figures are tokenizing their work at a rapid pace, driving a boom in purchase of collectible non-fungible tokens (NFTs). Profile pic (PFP) NFTs, examples of which include Bored Apes and Doodles, have become hot status symbols, and some of the world’s fastest-growing games are based in the Metaverse. With popular media outlets now feverishly reporting on NFT auctions, P2E games, and funding rounds, what were once collected only by the crypto-savvy are now mainstream.
However, with mainstream adoption is coming mainstream knowledge that NFT taxation is far from simple. In what follows, we'll go over what investors and creators need to know about reporting NFTs on their tax returns.
Are NFTs taxable?
Creating an NFT is not a taxable event.
However according to IRS guidance, any crypto-to-crypto transaction is a taxable event. Thus, all of the following NFT activities are taxable capital gain/loss events for hobbyists:
Purchasing an NFT with cryptocurrency
Trading an NFT for another NFT
Selling or otherwise disposing of an NFT for a fungible cryptocurrency
However, NFT taxes change if you create or trade NFTs professionally. In this case, many transactions will be considered ordinary income.
Read on for more information about NFT taxes for both investors and creators.
NFT taxes for investors
Purchasing an NFT with crypto
When you purchase an NFT with cryptocurrency, you’re also disposing of that cryptocurrency. This means you are also liable for capital gains taxes on any increase in that cryptocurrency’s value.
Purchasing an NFT example
You use 50 ETH to purchase a Bored Ape on OpenSea when ETH is trading for $4,000 (total of $200,000)
You had originally acquired the ETH when it was trading for $1,000 (total of $50,000)
You owe capital gains tax on the ETH’s increase in value by ($200,000 - $50,000 =) $150,000.
Selling an NFT
When you sell an NFT directly or on an exchange like OpenSea, you will owe capital gains tax on any increase in value of the NFT. Your crypto tax rates depend on how long you held the asset; if you had it for a year or less, you'll receive short-term rates. If you held it for longer than a year, you'll receive the favorable long-term rates.
NFT capital gains example
You purchased a CloneX avatar for 3 ETH when ETH was $4,000 (for a total purchase price of $12,000)
You later sold it for 4 ETH when ETH was $4,500 (for a total sales price of $18,000).
You recognized a taxable gain of $6,500.
To sum up, because crypto is considered an asset, you will incur tax liability when you trade crypto for an NFT—and when you dispose of said NFT for crypto.
NFT taxes for creators
Minting an NFT
Minting an NFT is not a taxable event.
Selling an NFT
Selling an NFT you created is a taxable event and any proceeds are income. If you are creating NFTs as part of your livelihood, the assets are essentially inventory, so your profits would be taxed as self-employment income, and you would owe additional self-employment taxes.
This would also likely apply if you worked as a digital art or NFT dealer.
Earning royalties on an NFT
The IRS has not issued any guidance about NFT royalty income. However, it is likely treated as self-employment if you are actively involved in minting NFTs. Alternatively, a one-off sale that generates royalties could likely be reported as passive income on Form Schedule E.
Donating an NFT
Increasingly, artists and investors are donating NFTs to museums or auctioning them for charity. Donating an NFT is not a taxable event. Additionally, donating an NFT can offset gross income, as long as certain criteria are met:
It was held over a year
It is donated to a 501(c)(3) organization
It is donated directly to the organization.
Trading an NFT for fiat or cryptocurrency is a taxable event. Hence, if an NFT is auctioned for charity without first being transferred to the 501(c)(3) organization, the NFT's former owner will owe capital gains taxes on the auction's proceeds—even though the proceeds were donated.
However, it is worth noting that with current tax law allowing 100% of AGI for cash donations, a donor could convert NFT proceeds into cash and make a donation large enough to wipe out their tax liability.
Play-to-earn (P2E) gaming taxes
Web3 has introduced a whole new category of online gaming, in which in-game assets (characters, tools, landscapes, etc.) are tokenized, and thus able to be owned by players and convertible to other asset types. These games are often called "play-to-earn," (P2E) because players can generate profits through actions like battling and breeding (ie- trading NFTs or other crypto assets).
Although the mechanics of each game differ, the key takeaway is that most actions in a play-to-earn game will be taxable, because they are crypto-to-crypto trades. Selling an in-game asset for a profit would be a capital gains event, while earning in-game assets for activity on the network would likely be income. For more specifics, check out our blog about taxes on the P2E game Axie Infinity.
What is the capital gains tax rate for NFTs?
If an NFT is sold or otherwise disposed of within a year of its purchase, it is subject to short-term capital gains tax rates, which are based on income level but can be up to 37%.
The IRS has not issued guidance on NFT taxation, leaving investors and tax professionals to speculate about how these assets should be treated when held long-term. Because of many NFTs' similarities with fine art and trading cards, some have speculated that they would be considered collectibles, and thus receive the higher 28% collectibles capital gains tax rate.
However, others argue that because buyers often purchase NFTs primarily as investment vehicles, the asset class would likely be treated as regular capital assets, and thus receive the normal crypto capital gains tax rate. This position reflects the fact that although a NFT may contain a PFP or an art file, many also come with financial benefits such as voting rights, accruing cash flows, or staking. As Deloitte recommends, it's important to consider each NFT uniquely.
Proponents of this position argue that instead of being considered collectibles, NFTs are more clearly classified as "digital assets," which the IRS has deemed subject to regular short-term and long-term capital gains rates. Finally, this opinion is bolstered by the fact that NFTS are "intangible" digital files and the tax code only gives the IRS the right to reclassify "tangible" objects as collectible items.
However, until the IRS issues guidance, the tax treatment of NFTs will remain a grey area. We recommend contacting a crypto tax professional and using NFT tax software before filing returns for NFT assets.
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Last reviewed by Zac McClure, MBA on September 20, 2022 · Sources