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Understanding NFT Taxes

By Zac Crites
Updated January 25, 2022


Today’s crypto audience is seeing digital artists’ lives changed by the increase in sales circulating around NFTs.

What is an NFT?

Non-fungible Tokens (NFT) are described as units of data that are being stored on a digital public ledger, called a blockchain.  These digital assets are unique and represent both tangible and intangible items, including:

  • Art
  • GIFs
  • Videos and sports highlights
  • Collectibles
  • Virtual avatars and video games skins
  • Designer sneakers
  • Music

You may be able to download any CryptoPunk from the internet, but each NFT project has a unique ID, tracked on the blockchain to show proof of ownership.  Simply downloading a digital file of an NFT does not mean you have ownership of that actual file.

CryptoPunk

Earlier this year CryptoPunk 7804 sold for $7.57 Million, reported by Larva Labs.

 

Are non-fungible tokens taxed?

Are NFTs Taxed as Collectibles?

The IRS has not issued any specific tax guidance when referring to NFTs, but according to Section 408(m)(2) “any work of art” is considered a collectible.

The IRS defines a collectible as:

  • Any work of art,
  • Any rug or antique,
  • Any metal or gem,
  • Any stamp or coin,
  • Any alcoholic beverage, or
  • Any other tangible personal property that the IRS determines is a “collectible” under IRS Section 408(m).

The taxation of NFTs depends on two interactions:

  • Create and sell NFTs in a marketplace, or
  • Buy and sell NFTs as an investor

NFT Creator Taxes

Creators are the artists of the NFT project.  When artists create an NFT this is also referred to as “minting.”  Those artists that mint NFTs would typically have a zero basis when selling their projects resulting in many sales being subject to ordinary income taxes and sometimes self-employment taxes.  This taxable event occurs once the NFT project has been sold on a marketplace of the artist’s choosing.

The top 10 NFT creators according to an article published by Influencer Marketing Hub are:

  • Beeple (Mike Winkelmann)
  • Trevorjonesart (Trevor Jones)
  • FEWOCiOUS
  • Pak
  • Maddogjones (Michah Dowbak aka Mad Dog Jones)
  • Hackatao
  • Xcopy
  • Slimesunday (Mike Parisella)
  • 3lau (Justin Blau)
  • Grimes

NFT Investor Taxes

NFT Investors typically buy and sell NFTs for investment opportunities.  According to IRS Notice 2014-21 these transactions are treated as property. NFTs are purchased with cryptocurrency, like Ethereum, and most likely will be treated in the same manner as cryptocurrency transactions according to the Internal Revenue Service.  Cryptocurrency records transactions securely on a distributed ledger, called a blockchain. Capital gains would be subject to either the long-term or short-term capital gains tax rate depending on the holding period.

Whether you are creating, selling, or investing in NFTs, it is very important to be cautious about the tax implications.  The more transactions that occur, will complicate the tracking and calculating of any tax.  Most platforms will not issue 1099 forms with cost basis information, so it is always in your best interest to keep records for all transactions involved.

 

How and Where to buy and sell NFTs

How to Buy NFTs

Individuals interested in purchasing NFTs may want to do their research and get themselves setup with a digital wallet of their choice.  Next, buyers will want to purchase cryptocurrency, depending on what currency is accepted from the NFT supplier.

NFT Marketplaces

NFT marketplaces are the platforms used to store, trade, and sell NFT projects. Each marketplace will differ, but traditionally you will need to create an account and connect a digital wallet to get started.

Buying an NFT

Buying NFTs is similar to buying products off of other digital applications, such as eBay.  Typically, uses can purchase NFTs directly for a fixed price or even in an auction format.  Depending on the marketplace, some platforms will allow buyers to submit offers to negotiate a price.

Selling an NFT

NFTs are traditionally sold on a marketplace like the following either by a fixed price or an auction format:

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