Guide to Taxes on Non-Fungible Tokens (NFTs)

Non-fungible tokens (NFTs) like digital art or collectibles are taxable. In this guide, we outline what you need to know for your crypto taxes.

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From Kings of Leon to the NBA to digital artists like Beeple and Pak, popular figures are tokenizing their work at a rapid pace, driving a boom in purchases of collectible non-fungible tokens (NFTs). With major media outlets now reporting on digital art NFT releases and auctions with feverish anticipation, what were once collected only by the crypto-savvy are now on the fast track to the mainstream.

However, although purchasing an NFT may seem simple from a tax perspective—a trade of currency for a product—the reality is more complicated.

Because NFTs themselves are crypto assets, and are typically purchased with cryptocurrencies such as Ethereum (ETH), DAI, or WAX, buying an NFT is considered a crypto-to-crypto trade by the IRS. This means you’re subject to taxes when buying and selling NFTs.

Punks

What are non-fungible tokens (NFTs)?

Non-fungible tokens (NFTs) are unique digital items on a blockchain.

If something is fungible, its units are considered mutually interchangeable. Corn is fungible; theoretically you can swap a pound of field corn with a different pound of field corn and still have the same value of corn. Cash is fungible; if you can break a $100 bill at the bank and receive five $20 bills in exchange, you have the same amount of money.

Cryptocurrencies are generally fungible; if you send 1 ETH to your friend and he sends you 1 ETH back, you have the same value of ETH as when you started (excluding Ethereum gas fees).

Something is non-fungible if you can’t exchange one of its units with another and necessarily have the same value. For example, gems are non-fungible because each one is unique. If you have one diamond, it would be very unlikely that if you exchanged it for a random diamond you would retain the same value since each diamond varies by size, cut, purity, etc.

NFTs are similar. A variety of files have been minted into NFTs, including music, video, text, and image. While the base files themselves may be reproducible, smart contracts create unique IDs and metadata for each NFT, making them un-interchangeable.

So, although anyone may be able to download an image file of one of digital artist Trevor Andrew’s Gucci Ghosts, each NFT set can have one contract address and each specific NFT has a unique ID. Even if two people exchanged Gucci Ghost tokens whose files were visually identical, they wouldn’t have the same assets they did before because each NFT’s data is different .

When do I owe taxes on an NFT?

Creating an NFT is not a taxable event. However per the IRS, any crypto-to-crypto transaction is a taxable event. Thus, all of the following NFT activities are taxable:

  • Purchasing an NFT with a fungible cryptocurrency
  • Trading an NFT for another NFT
  • Disposing of an NFT for a fungible cryptocurrency

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.

For example, if you purchased a CryptoPunk for 5 ETH when ETH was $1,000 (for a total purchase price of $5,000), but later sold it for 3 ETH when ETH was $2,000 (for a total sales price of $6,000), you would recognize a taxable gain of $1,000.

Remember the 5 ETH you used to get your CryptoPunk? Let’s say you had been holding it for 18 months when you purchased your Punk, during which time ETH’s value increased from $600 to $1,000. When you used that 5 ETH to buy an NFT, you were disposing of $5,000 worth of ETH for which you had only paid $3,000 and therefore owe tax on your $2,000 capital gain.

In other words, when you bought your CryptoPunk you incurred capital gains tax on your ETH. Several years later, when you sold your Punk, you incurred capital gains tax on the NFT itself.

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.

What is the tax rate on NFTs?

The IRS has not issued guidance on NFT taxation, leaving investors and tax professionals to speculate about how these assets should be treated. 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 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. You should contact a tax professional before filing returns for NFT assets.

Short-term capital gains rates

If an NFT is sold or otherwise disposed of within a year of its purchase, it is subject to short-term capital gains taxes, which are based on income level but can be up to 50 percent.

Consult your tax professional for more information on determining the appropriate tax rate for your NFTs.

Income tax rates

Certain NFTs may be taxed at ordinary income rates; if someone is, for instance, a digital artist or art dealer for whom NFTs are essentially inventory, those assets would not be subject to any favorable tax treatment. They would be taxed as income.

Consult your tax professional for more information on determining the appropriate tax rate for your NFTs.

FAQs on NFT taxes

What do I report if I bought an NFT in the last tax year?

If you used cryptocurrency that increased in value between the time you acquired it and the time you disposed of it in exchange for an NFT, you owe capital gains taxes on the value appreciated.

What do I report if I sold an NFT in the last tax year?

If you sold or otherwise disposed of an NFT, you owe capital gains taxes on any increase in the value of the NFT between the time you acquired it and the time you sold or otherwise disposed of it.

What do I report if I bought and sold the same NFT in the last tax year?

In this case, you will owe capital gains tax on both the fungible crypto you used to make the purchase and any gains accrued on the NFT while you held it. Furthermore, because you sold or otherwise disposed of your NFT less than a year after you purchased it, these gains will be subject to short-term capital gains tax rates.

I’m a digital art dealer. How do I report my sales and acquisitions?

For you, NFTs are essentially inventory for a business, so they don’t get special tax treatment. You will need to report purchases and sales of NFTs as income.

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