NFTs have taken the cryptoverse by storm. Whether you’re aping into Bored Ape Yacht Club, investing in digital land on Decentraland, or creating and selling your own digital art on SuperRare, NFTs have opened up a treasure trove of possibilities for artists and collectors alike.
You might know that selling an NFT is a taxable event, but did you know that purchasing an NFT with crypto is also a taxable event? Ouch. The last thing you want is an unexpected tax bill at the end of the year.
In this NFT tax guide, we'll demystify NFT tax treatment and detail some strategies to keep your tax burden as low as possible.
What are NFTs (non-fungible tokens)?
NFTs are assets tokenized on the blockchain. NFTs can be digitally native assets or digital assets that represent tangible assets like real estate. They're like a live, real-time certificate of authenticity. NFTs are programmable, composable, and verifiable. NFTs typically live on the ethereum blockchain, but in recent months other blockchains like Tezos have released smart contract functionality and support for NFTs.
What you do mean by "fungible" and "non-fungible"?
In economics, fungible or fungibility refer's to an asset's ability to be used interchangeably (e.g. $1.00=$1.00). NFTs are non-fungible because each NFT is cryptographically unique and therefore cannot be used transactionally like a currency. Even if someone were to upload the same media to mint an NFT, 1 NFT≠1 NFT.
On the other hand, bitcoin or other cryptocurrencies are fungible. They are functionally identical to each other (e.g. 1 bitcoin=1 bitcoin, 1 ETH=1 ETH) so they can be used transactionally.
The use-cases for NFTs include collectibles, digital art, game items, albums, event tickets, domain names, and ownership records for physical assets. But the possible applications for this new technology are only as small as our collective imagination.
While it seems like we’re in the midst of an NFT boom with frothy sales happening every day, we expect the long-term NFT market to mature and expand to other use-cases. In the not-so-distant future, everything from your car title, marriage certificate, and even your home might be tokenized on the blockchain.
How are NFTs taxed?
Technically, the IRS has not issued NFT-specific tax guidance (this will likely change in the future). But don’t be lax: NFT transactions must be reported on your 2021 tax forms since they're a crypto asset.
Whether you’re an artist selling your digital art or an investor buying and selling NFTs, it’s important to understand the tax implications of each activity.
Is purchasing an NFT taxable?
The short answer is yes. At first glance, it may seem like a simple tax treatment — exchanging currency for a good — but it can get more complicated than that. According to the IRS, any crypto-to-crypto transaction is a taxable event. And since you are disposing one asset for another, you may owe capital gains if the asset you're disposing for the NFT appreciated in value since you acquired it.
The following are generally considered taxable events:
- Trading one NFT for another NFT
- Selling an NFT for cryptocurrency (usually ETH) or fiat
- Purchasing an NFT with cryptocurrency
What are the tax implications for NFT artists?
For US citizens selling their NFTs, the tax considerations are pretty straightforward. Selling your NFT for cryptocurrency is treated as ordinary income and is taxed according to your income bracket (similar to getting paid in crypto). Additionally, any income you generate from selling your NFT is subject to self-employment taxes.
For example, suppose you sell an NFT for 1 ETH on an NFT marketplace like Rarible or Foundation. That profit is considered income.
Additionally, if you sell the 1 ETH you've earned for fiat or a different cryptocurrency, you'll be liable for capital gains if there's an appreciation in the price of ETH since you acquired it.
You can lower your NFT tax bill by deducting any fees you incurred creating, minting, or listing your NFT from your profits—just like you would deduct expenses from an ordinary job.
What are the tax implications for NFT collectors?
The tax considerations for collectors or investors are a little trickier. Let’s look at a few different scenarios:
Buying an NFT with cryptocurrency like ETH
Since you’re disposing of one asset for another (ETH for an NFT), that's considered a taxable event.
If the ETH you're using to purchase the NFT has appreciated since you've acquired it, you'll be liable for capital gains. If you held that appreciated ETH for less than a year, you'll owe short-term capital gains. If you held for over a year, you'll still be taxed but the rate will be more favorable.
If you bought an NFT with depreciated ETH, it’s considered a capital loss and can be used for tax-loss harvesting, which is a strategy to offset capital gains from other investments.
Pro tip: Buy the crypto you’re using to purchase the NFT on the same day that you buy the NFT. This way there's no major gain or loss.
Trading an NFT for another NFT
If you trade 1 NFT for another NFT of unequal value, that's a taxable event and you'll have to report a gain or loss from the transaction. For instance, if you sell an NFT you purchased for $1,000 worth of ETH for an NFT worth $2000 of ETH, you'll incur a taxable capital gain of $1,000.
Selling an NFT
As mentioned above, selling an NFT is a taxable event. If you buy an NFT for $5,000 and sell it for $8,000, then you'll incur a taxable gain of $3000. This is true whether or not you purchased the NFT with crypto or fiat.
How will NFTs be taxed in 2021 and beyond?
As previously mentioned, the IRS has not issued a formal statement on NFT tax treatment. But you can still take steps to stay ahead of the game and anticipate what you'll owe.
If NFTs are treated like other cryptoassets such as bitcoin and ETH, then you may owe long-term capital gains tax based on your income (ranging from 0-20%.) If NFTs are treated like collectibles (similar to trading cards, stamps, or antiques), the tax rate will shoot up to 28%.
However, if you sell the NFT in less than a year after purchasing, this will be recognized as a short-term capital gain regardless of whether NFTs are regarded as collectibles or not.
The bottom line
Exciting new things are popping up every day with this technology and it's all too easy to dive into the latest NFT project or start a new NFT business without considering the tax bill you're creating for yourself.
Stay informed and be proactive as the IRS continues to issue new guidance and don't let your accountant be a stranger. And most importantly, don’t lose track of your NFT transactions.
We recommend keeping tabs on your NFT transactions with automated crypto accounting software like Gilded.
Are you an NFT marketplace or business looking for a better way to track your finances, royalties, and revenue operations? Gilded can help with NFTOPS - the one-stop shop to manage your NFT marketplace's revenue operations.
Founded in 2018, Gilded is backed by Techstars and the Association of International Certified Public Accountants (AICPA). Gilded helps global companies scale by automating cryptocurrency payments and accounting. In 2020, Gilded announced partnerships with TrustToken, Paxos and Stablecorp to offer the world’s first B2B payment solution powered by stablecoins.