Recent Tax Updates
SUBSCRIBE TO CROSSLINK UPDATES

Understanding NFT Taxes

Updated: November 11, 2021


NFTs are currently taking the digital art and collectibles world by storm. Digital artists are seeing their lives change thanks to huge sales to a new crypto audience.

What is an NFT?

Physical money and cryptocurrencies (such as Bitcoin or Ethereum) are "fungible," meaning they can be traded or exchanged for one another. These items are equal in value. Crypto’s fungibility makes it a trusted means of conducting on the blockchain, which is a distributed public ledger that records transactions.

NFTs are different. A non-fungible token is a unit of data stored on a blockchain that certifies a digital asset to be unique and, therefore, not interchangeable. An NFT is created, or "minted" from digital objects that represent both tangible and intangible items, including:

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

Even tweets count in the NFT world.  Twitter co-founder Jack Dorsey sold his first ever tweet as an NFT for more than $2.9 million.

So, although anyone may be able to download an image file of a CryptoPunk (popular NFT project), each NFT project can have one contract address and each specific NFT has a unique ID.  While copies of these digital items are available for anyone to obtain, NFTs are tracked on blockchains to provide the owner with a proof of ownership that is separate from copyright.

A picture of CryptoPunk 7804

In early 2021, CryptoPunk 7804 sold for $7.57 Million.

Are non-fungible tokens taxed?

Are NFTs Taxed as Collectibles?

NFTs are likely treated as “collectibles” under tax code Section 408(m)(2). Although the IRS has not issued any NFT specific tax guidance yet, according to the Section 408(m)(2)(A) “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).

Similarly, it’s reasonable to assume that “trading card-like” NFTs, such as those on the NBA Topshot platform, will also be treated as collectibles. Physical trading cards have historically been treated the same way.

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 who create or mint NFTs and offer them for sale in a marketplace. This would mean the creator has no “basis” in what is being sold other than possibly the expenses related to creating it. The IRS, however, has an exception that allows artists to deduct expenses as they go rather than when the artwork is sold. If an NFT creator has deducted their expenses in a tax year prior to the year in which the NFT is sold, the creator has zero basis in the NFT.

Creators encounter a taxable event when they sell NFTs. The proceeds are subject to ordinary income taxes and sometimes self-employment taxes (15.3%). That means the profit or gain from an NFT they created with a zero basis would be a gain of 100% of the proceeds realized on the sale. Someone who creates an NFT and sells it for $500K has $500K of taxable profit.

Investors are individuals who buy and sell NFTs for investment opportunities. Generally, most people fall into this category. For NFT investors, taxes are like those for cryptocurrency trading. NFTs are often purchased using cryptocurrencies. Purchasing an NFT using Ethereum triggers a taxable event because you are disposing of a cryptocurrency, which is treated as a property per IRS Notice 2014-21.  For instance, if you bought an NFT on OpenSea with appreciated Ethereum, you would incur a capital gain and would need to pay taxes on this capital gain. Depending on how long you held the Ethereum before using it to buy the NFT, you would be subject to either the long term or short-term capital gains tax rate.

On the other hand, if you bought the NFT trading card with depreciated Ethereum, you would incur a capital loss and could use this to offset other capital gains and therefore lower your tax liability.

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 your best interest to keep records for all transactions involved.


Additional Information - How and Where to buy and sell NFTs

How to Buy NFTs

If you’re looking to start your own NFT collection, you’ll need to acquire some key items:
First, you’ll need to get a digital wallet that allows you to store NFTs and cryptocurrencies.  You’ll likely need to purchase some cryptocurrency, depending on what currencies your NFT provider accepts. You can buy crypto on platforms like:

You will then be able to move it from the exchange to your wallet of choice.

NFT Marketplaces

NFT marketplaces are platforms where NFTs can be stored, displayed, traded, and in some cases created.  Signing up to an NFT marketplace can differ from site to site, but for the most part, it will involve creating an account or connecting a supported digital wallet, or both.

Buying an NFT

NFTs are usually purchased directly for a fixed price or in an auction format.  In some instances, buyers may be able to submit offers to the owner to negotiate better pricing.

Selling an NFT

Selling an NFT is more complex than buying and typically, you will need to upload the digital asset onto the marketplace and enter a fixed price or opt to sell the NFT in an auction format. The asset will need to be verified and approved before the listing is live.

Here are 3 of the most popular NFT marketplaces currently available:

Are you prepared for Tax Season?

Free Pre-Season Business Checklists!

From software and banking setup to training and marketing tasks, make sure your tax business is ready by downloading your December Pre-Season Readiness Checklist today!

Download Now

Checklists