Are you an artist creating and selling NFTs for some quick cash? Or an avid collector of unique items that you might sell in the future? Maybe you’re just here to figure out what an NFT even is. Either way, we will teach you what they are and the resulting taxes that many people don’t realize are due along with them.
What are NFTs?
NFT stands for Non-Fungible (sounds like fun-juh-buhl) Token. NFTs are digital files that contain certificates of ownership and authenticity which cannot be duplicated, meaning they’re “one-of-a-kind.” A lot like Bitcoin and other cryptocurrencies, NFTs are created and tracked on blockchain technology. This means each NFT is tracked on an online distributed ledger. To be clear, when you own an NFT, you do not have ownership over a physical asset - what you own is a digital certificate for a virtual asset located on a public database.
Why Are My Tokens Non-Fungible?
Fungibility is the ability of a good or asset to be interchanged with other goods or assets of the same type and implies equal value between like assets. Money is an easy example of something fungible – a dollar can be exchanged for another dollar, four quarters, ten dimes, etc. Bitcoin is an example of a fungible token.
Conversely, a non-fungible asset is unique and not interchangeable. An example would be a car. If you traded a car for two smaller cars, that is not an equal exchange. And even if you traded a car for one of the exact same make, model, and mileage, it would not likely result in the same value being exchanged. There are too many other characteristics of a car that could affect the value because they each have a unique history.
Who Creates NFTs and What Taxes Do They Owe?
Artists, musicians, athletes, and other celebrities create these digital assets, but anyone with an understanding of NFTs can create their own. On its own, creating an NFT is not a taxable event. When the NFT is sold, that is when tax would be due. Creators of NFTs must pick up the sales of NFTs as ordinary income on their tax return, which is then taxed at their specific ordinary tax rate. If the person creates and sells NFTs for a living (i.e., above the level of a hobby), the sales will also be subject to Self-Employment taxes.
Who Buys NFTs and What Taxes Do They Owe?
Collectors, fans, and investors have been snatching up NFTs and sometimes for prices in the millions of dollars.
The purchase of an NFT is not a taxable event unless you purchase it with a cryptocurrency. Purchasing with a cryptocurrency is considered disposal of that cryptocurrency, so that is a taxable transaction (see our cryptocurrency taxation blog). Additionally, trading one NFT for another is also taxable, as remember, they are not of equal value or interchangeable assets. How long you hold the NFT before sale will determine the tax rate - either at short- or long-term capital gains tax rates.
Anything Else I Should Know?
As of the date of writing this, the IRS has no official stance on NFTs yet. There is a likelihood that the IRS may start to treat NFTs similar to stamps, antiques, or trading cards which have a special, higher collectibles tax rate of 28% when held over a year. We will keep our clients up to date on any developments around this issue.
Additionally, no 1099 or other tax form is issued for these transactions at this time. It is your responsibility to track and report these transactions, so we highly recommend you keep detailed records of what NFTs you buy and sell, and when/how much you buy and sell them for.
NFTs can be gifted and are subject to the same gift tax rules as other collectibles.
NFTs received as a reward (such as in exchange for retweeting a Company’s tweet) are taxable income to the receiver.