By George Batas, CPA
Did you know that over $17.7 billion has been spent on NFTs in 2021 alone? And that the most expensive NFT sold to date was worth $91.8 million? Given these numbers, you might be asking yourself, what is this booming industry, how can I get involved, and what are NFT tax implications? Well, let’s talk about it.
What is an NFT?
An NFT, or non-fungible token, is a digital asset that is unique and cannot be transferred. It represents both tangible and intangible items including art, GIFs, videos/sports highlights, collectibles, music etc. Each NFT is registered online using blockchain technology similar to the way that cryptocurrency works. The registration system allows each NFT owner to possess proof of ownership of that asset. You can’t simply download a digital file or take a screenshot of an NFT and say you have ownership of that actual file without authentication.
IRS Guidance on NFTs
Tax law is often slow to keep up with our ever-changing society. While NFTs have been around since 2014, their popularity and explosion into the mainstream scene only recently occurred in 2021. Due to the rapid uptick in popularity, the IRS has not yet had the ability to issue much guidance on NFT tax.
What we do know is that NFTs can be viewed as collectibles, investments, or inventory, and depending on which category it falls in, the taxation can vary greatly. To figure out the tax consequences of an NFT transaction, the first step is to figure out whether someone is a creator, investor, or trader of NFTs.
While this is a very new area and the IRS has not yet weighed in, the most likely NFT tax scenario for creators is that they will be subject to ordinary income tax and even self-employment taxes which would occur once the NFT project has been sold. The gain from the sale or exchange of the NFT for a creator will most likely be taxed as ordinary income because the NFT is part of the creator’s business. Likewise, any percentage from subsequent sale proceeds would be classified as ordinary income as well.
NFT investors are typically people who buy and sell NFTs at a profit. Therefore, unless the NFT falls outside of the definition of a capital asset, an NFT investment that is sold would be taxed as a capital gain.
An NFT trade occurs when an owner trades their NFT for someone else’s NFT or other cryptocurrencies. From the IRS perspective, if you are trading an NFT for another NFT, they will consider this a taxable transaction even though you never received any cash.
Whether you’re involved in creating, investing, or trading NFTs, it’s important to be aware of the tax considerations. When taxable events are triggered, it’s also important to know your whether your taxable gain is going to be considered capital in nature or ordinary.
Therefore, it’s critical to understand the full scope of the tax consequences and potential tax strategies available before any major transactions occur. While understanding the differences between ordinary income tax and capital gains tax on NFTs can be confusing, Sasserath & Co. can help clear the fog.
Contact us for guidance on your next NFT sale, investment, or purchase.