How are Non-Fungible Tokens (NFTs) Taxed?

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 .

Is purchasing an NFT a taxable event?

Per the IRS, any crypto-to-crypto transaction is a taxable event. Thus, all of the following are taxable events:

  • 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? Do they fall under the collectibles capital gains rate?

Profit earned from an increase in the demand for a cryptocurrency is generally subject to the regular capital gains tax rate. However, this is not necessarily true with NFT transactions, as many NFTs may be considered collectibles, and thus subject to a higher capital gains rate, or in rarer cases, as inventory, and thus subject to income tax rates.

Collectibles capital gains tax rate

Collectibles held longer than a year are a special segment of capital assets that are taxed at 28 percent, a higher rate than typical capital assets.

The IRS defines collectible capital assets as:

  • Any work of art,
  • Any rug or antique,
  • Any metal or gem (with exceptions),
  • Any stamp or coin (with exceptions),
  • Any alcoholic beverage, or
  • Any other tangible personal property that the IRS determines is a "collectible" under IRC Section 408(m).

Although the tax agency hasn’t issued definitive guidance on NFTs, it seems likely that crypto art NFTs will be subject to the collectibles rate.

Similarly, although trading cards are not specifically listed by the IRS, they have historically been taxed as collectibles, suggesting that NFT trading “cards,” like NBA Top Shots or CryptoKitties, would also be subject to the collectibles rate.

Consider NBA Top Shots, which are NFT video files of notable NBA plays. Many of these NFTs sell for under $100; however, because profit made from selling them is subject to capital gains tax at the collectible rate, all transactions must be reported and are subject to taxation at 28 percent.

For example, if someone buys an NBA Top Shot moment of an Anthony Davis dunk for the equivalent of $250, but trades it 18 months later for a Stephen Curry three-point shot worth the equivalent of $300, he or she would realize $50 of gains, 28 percent of which would be owed in long-term capital gains taxes. Multiplied over many similar trades, these transactions can amount to unexpectedly complex and high tax liabilities.

Consult your tax professional for further information on collectibles classification.

Regular capital gains rates

Although the media buzz around NFTs has focused primarily on digital art and other collectibles, there are NFTs that don’t fit into this category and would be taxed at the typical capital gains rate.

For example, in Uniswap v3, liquidity positions are no longer represented by fungible ERC20 tokens; rather, they are represented by NFTs. In this case, your NFT is not considered a collectible and would be subject to regular capital gains tax rates, which are based on the filer’s income level but capped at 20 percent.

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

Short-term capital gains rates

If an NFT is sold or otherwise disposed of within a year of its purchase, regardless of its status as a collectible, 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 art dealer for whom NFTs are essentially inventory, those assets would not be subject to any favorable tax treatment.

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

How can I make it easier to report NFT disposals on my taxes?

Sale of capital assets, including collectibles, are ultimately reported on your Schedule D. However, several forms and worksheets make it easier to compute your NFT taxes.

We recommend that you work with your collectibles separately from your other capital assets.

You and your CPA should use Form 8949 to report all collectible disposals, with short-term disposals listed in Pt I and long-term disposals in Pt II. Both types of disposals should be marked as collectibles.

Form 8949 Part II

After you've found the total gains (or losses) of your long-term collectibles trading, use the sum to complete the 28% Rate Gain Worksheet. You will ultimately report these calculations on your Schedule D along with your short-term disposal calculations.

28% Worksheet

For more detailed instructions on reporting your collectibles gains or losses, consult your tax professional.

The bottom line: What might I owe in 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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