NFT Tax Guide: Investing, Creating, Gaming and More | TokenTax
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 purchase of collectible non-fungible tokens (NFTs). Profile pic (PFP) NFTs like Mutant Apes have become hot status symbols, and some of the world’s fastest-growing games are based in the Metaverse. With popular 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 mainstream.
However, with mainstream adoption is coming mainstream knowledge that NFT taxes are far from simple. In what follows, we’ll go over what investors and creators need to know about reporting NFTs on their tax returns.
Creating an NFT is not a taxable event. However per the IRS, any crypto-to-crypto transaction is a taxable event. Thus, all of the following NFT activities are taxable capital gain/loss events for hobbyists:
Purchasing an NFT with cryptocurrency
Trading an NFT for another NFT
Selling or otherwise disposing of an NFT for a fungible cryptocurrency
However, tax treatment changes if you create or trade NFTs professionally. In this case, many transactions will be considered ordinary income.
Read on for more information about NFT taxes for both investors and creators.
Purchasing an NFT with crypto
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.
If you used 50 ETH to purchase a Bored Ape when ETH was trading for $4,000 (total of $200,000), but had originally acquired the ETH when it was trading for $1,000, you would owe capital gains tax on the ETH’s increase in value of ($200,000 – $50,000 =) $150,000.
Selling an NFT
When you sell an NFT, you will owe capital gains tax on any increase in value of the NFT.
For example, if you purchased a CloneX avatar for 3 ETH when ETH was $4,000 (for a total purchase price of $12,000), but later sold it for 4 ETH when ETH was $4,500 (for a total sales price of $18,000), you would recognize a taxable gain of $6,500.
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.
Minting an NFT
Minting an NFT is not a taxable event.
Selling an NFT
Selling an NFT you created in exchange for cryptocurrency is a taxable event and any proceeds are income. If you are actively involved in creating NFTs for a living, the assets are essentially inventory, so your profits would be taxed as self-employment income, and you would owe additional self-employment taxes.
This would also likely apply if you worked as a digital art or NFT dealer.
Earning royalties on an NFT
The IRS has not issued any guidance about NFT royalty income. However, it is likely treated as self-employment if you are actively involved in minting NFTs. Alternatively, a one-off sale that generates royalties could likely be reported as passive income on Form Schedule E.
Increasingly, artists and investors are donating NFTs to museums or auctioning them for charity. Donating an NFT is not a taxable event. Additionally, donating an NFT can offset gross income, as long as certain criteria are met:
It was held over a year
It is donated to a 501(c)(3) organization
It is donated directly to the organization.
Trading an NFT for fiat or cryptocurrency is a taxable event. Hence, if an NFT is auctioned for charity without first being transferred to the 501(c)(3) organization, the NFT’s former owner will owe capital gains taxes on the auction’s proceeds—even though the proceeds were donated.
However, it is worth noting that with current tax law allowing 100% of AGI for cash donations, a donor could convert NFT proceeds into cash and make a donation large enough to wipe out their tax liability.
Web3 has introduced a whole new category of online gaming, in which in-game assets (characters, tools, landscapes, etc.) are tokenized, and thus ownable by players and convertible to other asset types. These games are often called “play-to-earn,” (P2E) because players can generate profits through actions like battling and breeding (ie- trading NFTs or other crypto assets).
Although the mechanics of each game differ, the key takeaway is that most actions in a play-to-earn game will be taxable, because they are crypto-to-crypto trades. Selling an in-game asset for a profit would be a capital gains event, while earning in-game assets for activity on the network would likely be income. For more specifics, check out our blog about taxes on the P2E game Axie Infinity.
If an NFT is sold or otherwise disposed of within a year of its purchase, it is subject to short-term capital gains tax rates, which are based on income level but can be up to 37%.
The IRS has not issued guidance on NFT taxation, leaving investors and tax professionals to speculate about how these assets should be treated when held long-term. Because of many NFTs’ similarities with fine art and trading cards, some have speculated that they would be considered collectibles, and thus receive the higher 28% collectibles capital gains tax rate.
However, others argue that because buyers often purchase NFTs primarily as investment vehicles, the asset class would likely be treated as regular capital assets, and thus receive the normal crypto capital gains tax rate. This position reflects the fact that although a NFT may contain a PFP or an art file, many also come with financial benefits such as voting rights, accruing cash flows, or staking. As Deloitte recommends, it’s important to consider each NFT uniquely.
Proponents of this position argue that instead of being considered collectibles, NFTs are more clearly classified as “digital assets,” which the IRS has deemed subject to regular short-term and long-term capital gains rates. Finally, this opinion is bolstered by the fact that NFTS are “intangible” digital files and the tax code only gives the IRS the right to reclassify “tangible” objects as collectible items.
However, until the IRS issues guidance, the tax treatment of NFTs will remain a grey area. We recommend contacting a crypto tax professional before filing returns for NFT assets.
This content was originally published here.