Technically, the IRS has not issued NFT-specific tax guidance. But, NFT transactions must be reported on your tax forms since they’re a crypto asset. Let’s start talking about NFTs first.
What is NFT?
An NFT (Non-fungible tokens) is a digital asset that represents real-world objects like art, music, in-game items, and videos. These tokens are based on Ethereum blockchain technology, cannot be replaced by any other value, and are unique in that sense. If we take as an example a real image from the market, NFT token can be considered digital works of art, such as graphics, images, photographs, music, parts in video games, whose value is expressed in Ethereum or Bitcoin cryptocurrency whose value is later translated into dollars.
NFT behaves like a cryptocurrency — it exists on a blockchain, it has value, it can be traded. On the other hand, it is visually striking enough to be better called NFTs creation or even simpler NFTs digital assets.
These tokens are characterized by uniqueness — just as a work of art can be unique. There are also partially unique tokens, but also those that are more but are limited in number. Among others, this is a feature that significantly affects the price. NFT is also indivisible, this token cannot be divided into halves, or into several parts, but acts exclusively in its entirety, unlike, for example, bitcoin.
One of the largest markets for NFT, more precisely virtual assets, is OpenSea, where there are a variety of GIFs, animations, simple graphics, and whose creators can earn millions of dollars by buying some of these works of art, which we will talk about later in the webinar.
How do NFTs work?
Although they’ve been around since 2014, NFTs are gaining notoriety now because they are becoming an increasingly popular way to buy and sell digital artwork. In 2017 the world witnessed the birth of CryptoKitties. NFTs are a unit of data, specifically blockchain-based digital files, but it is important to say that access to any copy of the original file is not limited to the owner of the token. Although the digital files themselves are infinitely repeatable, the NFTs that represent them are tracked on their core blocks and provide customers with proof of ownership of the NFTs.
As the NFT principle is based on uploading digital materials to the Ethereum blockchain, this procedure leads to the codification of NFT, which later leads to the establishment of price, ownership, and transfer records, thus preventing digital forgery or file replication. Once shipped, NFT will exist permanently on the blockchain as long as the system itself is operational.
There are no two NFTs that are completely identical because each piece contains unique digital properties. Even if the artist publishes two works without clear physical differences, the metadata encoded in each NFT is different. However, what is important to say here is that within the NFT system and tokenization, it is necessary to fully protect intellectual property.
Apart from artists, celebrities also had their notable and significant share in NFT token trading. Namely, in 2019, the NBA league released Top Shots, more precisely short summaries of games in reels format, which generated 230 million dollars via blockchain. The clip of LeBron James and Zion Williamson alone had a value of 200,000 dollars. A well-known musician in the United States, 3LAU sold his first crypto-album through an auction in less than 24 hours for 11 million dollars. YouTuber Logan Paul also sold his NFT, more precisely his graphical version of Pokemon for $ 5 million.
NFTs are typically held on the Ethereum blockchain, although other blockchains support them as well. An NFT (non-fungible token) simply represents ownership of an asset. Before choosing an NFT marketplace, you’ll first want to decide the kind of digital asset you’re interested in buying, selling, or creating
Some of the biggest marketplaces are
- OpenSea,- the world’s first and largest digital marketplace for crypto collectibles and non-fungible tokens. It launched in 2017 with $2 million in start-up funding. The company recently raised an additional $23 million in April 2021 with the help of the venture capital fund of Andreessen Horowitz
- Rarible — another large marketplace for all sorts of NFTs, similar to OpenSea. All kinds of art, videos, collectibles, and music can be bought, sold, or created on the platform. The company has partnered with some notable companies
- SuperRare — also building a marketplace for digital creators. The site includes art, videos, and 3D images, but collectors can purchase artwork using Ethereum
- Foundation — Since the marketplace’s launch in early 2021, it has sold more than $100 million of NFTs. Artists are invited to the platform by the Foundation community, and buyers simply need a crypto wallet funded with Ethereum to start making purchases
- Axie — Axie Marketplace is the online shop for the video game Axie Infinity. Axies are mythical creatures that can be bought and trained and then pitted against other players’ Axies to earn rewards.
And much more marketplaces.
How NFTs are taxed?
NFTs are also subject to capital gains taxes — just like when you sell stocks at a profit. Since they’re considered collectibles, however, they may not receive the preferential long-term capital gains rates stocks do and may even be taxed at a higher collectibles tax rate, though the IRS has not yet ruled what NFTs are considered for tax purposes. In most cases, yes, NFTs (non-fungible tokens) are subject to the same tax laws as fungible cryptocurrencies.
There are three situations where you could owe NFT taxes without ever receiving any cash in hand. These include purchasing an NFT using a cryptocurrency, trading one NFT with another, and earning royalties in cryptocurrency. Unfortunately, most NFT holders are not aware of these rules. This could result in large and surprising bills come tax day, which you may not have the cash to pay.
NFTs have allowed charities, celebrities, and individuals to auction off their digital creations, with all the proceeds going to a charity of their choice. If you’ve donated your NFTs, to eligible charities, then you may qualify for the reduced tax liability. When you donate an asset, you can claim the appreciated fair market value at the time of donation as a deduction against your taxable income. For example, if you own $50,000 worth of artwork and choose to donate it to a charity you regularly support, you may be able to write this off as a charitable deduction on your return.
Currently, NFT marketplaces do not provide you with any tax documents nor any transaction history reports to figure out your NFT capital gains and losses. So, it is your responsibility to keep detailed records, figure out the correct cost basis & market values, and accurately file taxes.
Creating an NFT in itself is not a taxable event. However, selling the NFT on a marketplace like OpenSea or Rarible is. When you sell an NFT, you will have to pay taxes on the profits.
if you bought an NFT trading card on OpenSea for example, 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, you would incur a capital loss and could use this to offset other capital gains and therefore lower your tax liability.
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.
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.
Furthermore, you can invest in art. While investing in art results in higher capital gains rates, you may be able to deduct certain art-related expenses. Receiving deductions for purchasing art depends on how the IRS classifies your activities. As a collector, you cannot deduct any expenses related to the purchase, transportation, or maintenance of a piece of art. Alternatively, you may receive investor status. In this case, the IRS lets you deduct these expenses.
If the IRS decides to offer investors in NFTs the same tax classifications as investors in art, some tax deductions may exist. Similarly, if you must pay for specific software to store and secure your collection of NFTs, that would likely qualify for a tax deduction.