NFTs: What Are They, and How Will They Impact Your Taxes?

Posted by Mariya Tsanova on Mar 23, 2022 12:11:42 PM
Mariya Tsanova
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In the cryptocurrency world, NFTs are the latest craze. But what exactly is an NFT?

NFTs—or Non-fungible Tokens—are unique, identifiable digital assets that are accompanied by a digital certificate of ownership. Similar to cryptocurrencies like Bitcoin and Ether, NFT ownership is recorded on a Blockchain. However, unlike cryptocurrencies, which are fungible (meaning they are interchangeable and not unique), an NFT is a unique piece of digital content.

NFTs can include digital art, music, autographed memorabilia, trading cards, or other collectibles. Like any collectible, the value of an NFT is determined by what someone is willing to pay for it. For example in 2021, digital artist Beeple sold an NFT—a collage of pictures—at Christie’s for $69 million dollars. The buyer, who paid for the NFT in Ether, received the digital file, plus some rights to present the image.

NFTs are designed to ensure that a given piece of digital content is unique and owned by a single person or entity at a specific point in time. Because they live on a Blockchain (usually the Ethereum Blockchain), which is maintained by thousands of computers worldwide and viewable by anyone, ownership of the NFT can be easily confirmed and difficult to forge.

Are NFTs taxed?

While the IRS has provided some guidance on cryptocurrencies, they have not yet issued any specific guidance regarding the tax issues surrounding NFTs. The IRS has stated that cryptocurrencies should be treated as property and taxed as such. While NFTs do not function as currency, they are similar to cryptocurrencies in many ways and may also be treated as property.

However, the most pressing issue is whether NFTs should be treated as “collectibles” for purposes of capital gains tax, which would render them subject to a higher rate when held for more than one year.

Collectibles are defined by the IRS as “any work of art, any rug or antique, any metal or gem, any stamp or coin, any alcoholic beverage, or any other tangible personal property specified by the Secretary for purposes of this subsection”. As digital assets, NFTs are intangible, and a plausible argument can be made that they should not be considered collectibles, however further guidance is needed.

Taxable NFT Activities

NFT activities that trigger a taxable event include:

  • Creating and Selling an NFT for cryptocurrency
    Creating an NFT does not trigger a taxable event, however when you sell an NFT that you have created, you will have to pay tax on the profits, which are considered income and taxed at your ordinary income tax rate. This income will also be subject to self-employment taxes, at a rate of 15.3%.

  • Buying an NFT, trading an NFT for another NFT, or selling an NFT
    Whether you purchase an NFT with cryptocurrency, trade one NFT for another, or sell an NFT for cryptocurrency, you will create a taxable event. The gain from capital assets held for more than one year is taxed on preferential rates of 0%, 15% or 20% depending on the taxable income, but the capital gain from collectibles held for over a year is subject to a 28% tax rate.

NFT Trading Fees

For tax purposes, it is important to document all fees associated with creating, buying, holding, and selling NFTs and the cryptocurrencies used to trade them—and there are many fees involved. There can be fees to create a digital wallet, purchase cryptocurrencies, exchange one cryptocurrency for another, transfer funds between wallets, purchase an NFT, list an NFT for sale, sell an NFT, collect or pay royalties on future sales of an NFT, and the highly variable Ethereum “gas fee”—which could be as high as 10% of the selling price of the NFT, and is impacted by how busy the network is at the time of the transaction, how quickly the transaction settles, how complicated the transaction is, and the going price of gas.

Whether you’re creating or investing in NFTs, it’s important to be aware of the tax implications. If you have questions about how NFTs might impact your taxes, leave a comment below or feel free to contact me directly, I’m happy to help.

Topics: Tax, Cryptocurrency