When NFTs Make You Say WTF

We’ve seen the arrival of cryptocurrency. We’ve seen it rise to great heights and are now watching it plunge to new lows. Some investors have made millions, while some have lost millions. The IRS has been trying to figure out how to tax crypto for years, and finally, in 2014 started offering tax guidance. Even the smallest crypto investors now know the IRS is able to track their trades.

According to one source, “The 2014 IRS policy, however, only applies to fungible (identical in value and interchangeable) cryptocurrency, but the agency has not ruled out taxing other digital assets as they develop. A new kind of virtual token has evolved, the nonfungible token (NFT). In other words, these are unique and not interchangeable with other NFTs. NFTs can represent, for example, unique physical assets like real estate or artwork, or potentially intellectual property interests like those in licenses or written creative works.” https://www.zenledger.io/guides/nfts-crypto-taxes

Ethereum defines an NFT as a token “used to identify something or someone in a unique way … [like] collectible items, access keys, lottery tickets, numbered seats for concerts and sports matches, etc.”

As you can imagine, NFTs are now giving the IRS something new to wrap their arms around, track and tax. Think about the confusion for taxpayers using cryptocurrency to buy NFTs! If you are dealing in NFTs, or thinking about doing so, you’ll want to keep the IRS in mind. I’m reprinting a small portion of an article that spells out the current IRS guidance regarding NFTs.

NFT Taxes: What Are Investor Taxes?
Most of the individuals dealing with NFTs are investors. These are the people who are involved in buying and selling NFTs in the open market. For them, taxes work the same way as they do for crypto trading.

Purchasing NFTs 

When you buy NFTs using cryptocurrency, it is taxable.

For example, years ago Kim purchased 2 ETH @ $500/ETH ($1000 total). In March 2021, Kim used this same 2 ETH to purchase a Bored Ape NFT, but ETH is now worth $1000 so the purchase of the Bored Ape is for $2000. Kim incurred a capital gain of $1000, from the increase in value of her 2 ETH, and is taxable upon exchange for the NFT. 

Selling NFTs

Another taxable event is selling your NFT for crypto, fiat currency, other NFTs, or even goods and services. 

Let’s take the same example. If Kim sold her NFT for $12,000 after 6 months, it would qualify for short-term capital gains of $10,000 ($12,000-$2,000). Short-term gains are taxable at ordinary income rates of tax.

NFT Taxes: What Are Creator Taxes?

The creation of NFTs is not taxable. However, any crypto transactions related to NFTs are considered taxable according to the Internal Revenue Service (IRS).

Creators are the ones who mint or create NFTs and list them for sale on various marketplaces, such as SuperRare and OpenSea. 

NFT creators are of two types:

  • Hobby creators: they mint NFTs for fun
  • Professional creators: they mint NFT’s as a full-time trade

Selling NFTs

Selling NFTs for any crypto or even exchanging an NFT for another NFT is taxable for NFT creators.

NFT Royalties

Earning recurrent royalties is taxable as well.

NFT Airdrops

Holders of popular NFT projects like Cryptopunks and Bored Ape Yacht Club will often find that they are being airdropped (given for free) coins or other NFTs that have monetary value. Oddly enough, airdropped tokens are one of the few things that the IRS has provided explicit guidance on; airdrops are to be taxed as ordinary income. The amount of this income being the value in USD of the airdropped coins/tokens at the time they hit the wallet. https://www.zenledger.io/guides/nfts-crypto-taxes

Stay IRS Compliant

If you are exploring NFTs, it’s important to avoid any trouble with the IRS by staying IRS compliant. It’s a complicated and confusing new world for taxpayers. I’ll continue to provide tax information about NFTs and cryptocurrency, and help clients stay compliant.

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