Non-fungible tokens (NFTs) are one-of-a-kind tokens representing digital assets like artwork, music, or even in-game items. They have been around since 2014 but have exploded in popularity in recent months after digital artist, Beeple, sold an NFT-linked digital collage at Christie’s last March for $69 million.
If you are thinking of buying or selling NFTs as an artist or an investor, it is important to be aware of the tax implications.
Here is what you need to know.
What is an NFT?
NFTs are digital assets stored on a blockchain. NFTs can be bought and sold like any other asset, and their value depends on market demand. However, unlike cryptocurrencies, which are exchangeable for other cryptocurrencies or fiat currencies, NFTs contain a digital signature that makes each one unique so that it cannot be exchanged for other assets. This distinction makes them ideal for storing digital art, music, and other collectibles.
NFTs are unique and can be authenticated easily. Transactions can be completed quickly and without high fees. They also do not depreciate over time, as physical assets can. For example, an original painting can be damaged or faded over time; an NFT will always remain the same. While there is still skepticism about the value of NFTs, the art industry has helped propel them into more mainstream commerce, as a way to invest in the future of the digital economy. Only time will tell whether NFTs will become a mainstream currency or remain a niche investment.
What Are the Tax Implications of NFTs?
The IRS has categorized all fungible cryptocurrencies as property. NFTs are subject to the same tax laws as fungible cryptocurrencies, like Bitcoin or Ethereum. Taxes on NFTs are typically calculated as capital gains or losses. If you sell an NFT for more than you paid for it, you will owe taxes on the profit.
If you sell an NFT for less than you paid, you can deduct the loss from your income subject to certain limitations. The tax implications of NFTs will be different depending on whether you are a creator, buyer, or seller.
The most common taxable NFT events include:
- Selling an NFT
- Purchasing an NFT with cryptocurrency
- Exchanging or trading one NFT for another
As the popularity of NFTs continues to grow, the IRS is likely to provide more guidance on their taxation. Most NFT platforms do not offer specific tax guidance for the purchase and sale of NFTs. However, this does not mean you can ignore the tax implications of NFTs. The best way to stay up to date on the latest tax guidance for NFTs is to consult with a tax professional.
How Is the Seller Taxed?
If you sell an NFT that you created, you need to report the sale as income and pay taxes on the profits. NFTs are taxed differently than other cryptos because they are considered stock in trade. The IRS views profits from selling NFTs as income, which is taxed at your ordinary-income tax rate. The rate varies from 10% to 37%, based on your tax bracket. It is essential to report your income this way, whether paid in dollars, bitcoin, ether, or any other cryptocurrency.
In some cases, this income may be subject to self-employment taxes if the creation of NFTs is more than your hobby. You should consult a tax professional to make sure you are reporting your NFT income correctly and paying your taxes correctly.
How Is the Buyer Taxed?
If you use cryptocurrency to buy an NFT, you are taxed on the transaction as if you sold the cryptocurrency. The value of the crypto at the time of purchase will be your cost basis in the NFT. You will either incur capital gains or loss on the transaction depending on how much the cryptocurrency is worth when you sell it.
How Are Traded or Exchange NFTs Taxed?
Trading an NFT for another is not a tax-free exchange. The trade typically results in a capital gain or capital loss.
For example, if you buy an NFT for $2,000 and trade it six months later for another NFT worth $3,000, you will incur a short-term capital gain of $1,000. Short-term capital gains are taxed at your marginal tax rate.
In contrast, you would incur a long-term capital gain if you held the original NFT for more than a year before trading it for another NFT. Long-term capital gains are generally taxed at a lower rate than short-term gains.
How Can I Minimize My Taxes When Buying or Selling NFTs?
If you are thinking of buying or selling NFTs, you can consider the following strategies as ways to reduce your tax liability:
- Trade one NFT with a cost basis higher than the exchanged for NFT so you can take a loss on the transaction. This will help lower your taxes overall. You can do this in situations when the market value of an NFT has dropped since you purchased it. In this case, you can sell the NFT at a loss and use the losses to offset other capital gains.
- Donate your NFT to a charity. You can take a tax deduction for its fair market value.
- You can offset your capital gains from selling NFTs with losses from other investments. For example, if you have crypto losses from trading Bitcoin, you can use those losses to offset your gains and lower your overall tax bill.
- Lastly, you can invest in an NFT fund. These are investment vehicles that hold a basket of NFTs and other crypto assets. By investing in an NFT fund, you can spread your risk across different types of NFTs and may reduce your overall tax liability.
When it comes to taxes, there usually is no one-size-fits-all solution. The best way to minimize your taxes is to speak with a tax professional who can help you understand the tax implications of your specific situation.
A tax professional can help you determine if you have a taxable event when you sell or exchange your NFTs and advise you on the best way to minimize your tax liability. In addition, they can help you comply with the disclosure requirements for NFTs and ensure that you are reporting your transactions correctly on your tax return.
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Klug Counsel PLLC represents companies, start-ups, private equity funds, family offices, and high-net-worth individuals. Through their strategic partnerships with law firms and other professional service firms in the U.S. and around the world, they are able to meet the tax and business needs of their clients in the U.S. and internationally.
Klug Counsel is at the forefront of digital currency, as well as asset tax preparation and structure. Their team of crypto lawyers helped prepare the tax structure for a crypto mining company, including the tax-efficient acquisition of a power plant, and the offshore structuring of $350 million worth of equipment.
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