Everything You Need To Know On How To File NFT Taxes

NFT Tax Guide

An outline of NFT tax implications for NFT creators, collectors, investors & traders.

Introduction:

NFTs have taken the crypto markets by storm. According to NonFungible, sales of NFTs rose by 3491% (approximately 2 Billion) in the last 2 months alone! Global brands, digital artists, and popular figures entering the NFT world is the driving force behind a boom in the purchase of NFT collectibles:

and the list goes on….

However, most NFT creators & collectors may look at their selling or purchasing activities like this:

  • Creator selling a product (NFT) for money (ETH)
  • Collector purchasing a product (NFT) with money (ETH).

In reality, this is not how IRS (federal agency responsible for collecting taxes in the U.S) would consider this trade for tax purposes! Since NFTs are themselves considered to be crypto assets, IRS looks at it as a crypto-to-crypto trade:

  • Creator selling a crypto (NFT) for crypto (ETH)
  • Collector buying a crypto(NFT) with crypto (ETH)

This means you have to pay taxes on selling (profits made on NFT buy and sell price), as well as buying (profit or loss made on selling ETH).

Disclaimer: Regulations in the crypto space change rapidly. This article could be out of date when you read it – it moves that fast! Let us know if something needs to be updated through our chat support on the bottom right corner. This is not a professional accounting advice and one must consult their CPA for advice on appropriate NFT tax rates.

What are non-fungible tokens (NFTs)?

Digital tokens stored on a blockchain network are called as NFTs. The token represents a digital or physical asset.

For eg: If you own a real estate, you’ll also have a legal document on paper, certifying your ownership of the asset. Now imagine the contents of this legal document being written in code and stored as a token on a blockchain network. That’s the NFT (digital token) of your real estate!

Various assets – collectibles, digital art, in-game assets, albums, event tickets, domain names, ownership records of physical assets, videos, images, music, text, and event tweets – can be minted as NFTs and sold on a marketplace.

Why are these digital tokens called non-fungible tokens (NFTs)?

Something is fungible when one of its units can be replaced with a similar item. For eg: You can exchange a $1000 bill for ten $100 bills.

Generally, cryptocurrencies are fungible. For eg: At today’s price rates, you can exchange 13.29 ETH for 1 BTC.

However, NFTs are called non-fungible because 1 unit of an NFT can’t be exchanged for 1 unit of another NFT. For eg: 1 unit of your real estate cannot be exchanged for 1 unit of some other real estate. Simply because their size, cost, and other attributes vary significantly.

Therefore, NFTs cannot be used as a currency. They are considered a crypto asset because they run on blockchain technology.

When do I owe taxes on NFTs?

The IRS has not yet issued an NFT specific tax guidance. However, since NFT is considered as a ‘crypto asset’, any trades involving NFT will be seen as a crypto-to-crypto transaction by the IRS.

In that sense, NFT trades will be subject to the same tax laws as crypto transactions. Capital gains & losses must be reported for the following taxable NFT activities:

  • Purchasing an NFT with a fungible cryptocurrency
  • Trading an NFT for another NFT
  • Disposition (Selling) of an NFT for a cryptocurrency

However, NFT creation is not a taxable event. Read tax implications for NFT creators here

How to calculate capital gains & loss on NFT activities?

Gains & losses are calculated by taking the fiat price difference between the purchase price of an NFT & the price at which it was sold.

If you had used a fungible cryptocurrency like Ether to buy the NFT, then you’re ‘disposing’ of that cryptocurrency. So, you will also have to record the difference between the purchase price of the cryptocurrency and the price at disposal to calculate a gain or loss on it.

Let’s understand with an example:

Purchasing an NFT with Ether (ETH):

Adam purchases a cryptopunk with 3 ETH when ETH is worth $1000 (for a total purchase price of $3000). Let’s say he had originally purchased that 3 ETH over two years ago when ETH was worth $500 (total purchase price of $1500). This means he was holding his 3 ETH for two years, during which period he has incurred a capital gain on the increase in ETH’s value.

Capital gain = Total purchase price of NFT – Total purchase price of Ether

= $3,000 – $1,500 = $1,500

Selling of an NFT for Ether (ETH):

Three months later, cryptopunks started trending on twitter and there is suddenly a huge demand for them. Adam decides to capitalize on this and lists his cryptopunk for sale for 2 ETH – which is worth $2500 each at the time. Within minutes, someone buys it from him for a total sales price of $5,000. But, remember he had bought it for only $3000. Therefore, he is liable to pay capital gains tax on the profit.

Capital gain = Total sales price of NFT – Total purchase price of NFT = $5,000 – $3000 = $2,000

Total capital gains

= Capital gain from purchasing NFT + Capital gain from selling NFT = $1,500 + $2,000 = $3,500

Adam would be liable to pay a total capital gains tax on $3,500.

Note: You must also add and subtract the gas fee paid for purchasing and selling the NFT respectively.

What is the tax rate on NFTs?

Tax rate on NFTs depends on the following factors:

  • Short-term & long-term capital gain
  • Whether the NFT is treated as ‘collectibles’ by the IRS

Short-term capital gains rate:

If ‘NFT was sold’ or ‘crypto was disposed to buy NFT’ in less than a year of its purchase, profit made on ‘selling’ or ‘disposing’ would be treated as a short-term capital gain and will be taxed at the same rate as the person’s income tax bracket.

Long-term (OR) Regular capital gains rate:

If ‘NFT was sold’ or ‘crypto was disposed to buy NFT’ after more than a year of its purchase, profit made on ‘selling’ or ‘disposing’ would be treated as regular capital gains tax rates, which are based on the filer’s income level but capped at 20%.

Collectibles capital gains tax rate:

As mentioned before, the IRS has not yet issued NFT specific tax guidance. However, ‘any work of art, stamps or coins’ are treated as “collectible capital assets” under IRC Section 408(m)(2).

This would mean ‘crypto art NFTs’ like CryptoKitties, CryptoPunks, and BoredApe will most likely be treated as ‘collectibles’. If such collectibles are sold after more than a year of purchase, profit made on selling is taxed at a collectibles capital gains tax rate of 28%.

For eg: If Adam buys a CryptoPunk for the equivalent of $750, but trades it 18 months later for a BoredApe equivalent of $1000, he is liable to pay 28% tax on a capital gain of $250. Multiplied over many similar trades, his transactions can amount to unexpectedly complex and high tax liabilities.

Please consult a tax professional for advice on collectibles classification and appropriate tax rates for your NFTs.

Tax Implications for NFT Creators:

NFT creators are artists who create NFTs and put them for sale in marketplaces like SuperRare, Nifty Gateway, OpenSea, etc.

Though NFT creation is not a taxable event, income earned from selling their own NFTs is taxable. It must be reported as ordinary income and will be subject to self-employment taxes as well.

If you’re an NFT creator by profession, you can also deduct ordinary and necessary business expenses to offset your taxable income.

Please consult a tax professional for advice on the appropriate tax rate for your NFTs.

Conclusion:

Whether you’re creating, investing, trading, or flipping NFTs, it is necessary to understand the tax implications of your transactions. NFT marketplaces don’t provide cost basis information on the original purchase price of the “crypto you are disposing of” and the “NFT you are selling”.

You will have to manually keep records of both – the crypto used to purchase the NFT and the NFT itself. The more transactions you do, the more complicated it will get to track the prices and calculate gain or loss.

You can simplify the process by using crypto tax software like bear.tax. You’ll just have to upload all your trades and the software will calculate gain or loss and generate your tax forms.

What the future holds

The NFT world is continuously evolving and the introduction of new concepts and gamification could change how things are taxed. Follow us to stay updated!

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