The IRS wants to tax non-fungible tokens (NFTs) as collectibles and is seeking public comments on whether that's a good idea. If NFTs are treated as collectibles, any profit you make from selling one could be subject to a higher capital gains tax rate.
- The IRS is considering taxing NFTs as collectibles.
- Long term capital gains tax for collectibles is capped at 28%, which is higher than other assets.
- Questions remain about tax implications for NFT creators
IRS Plan To Tax NFTs As Collectibles
On Tuesday, the IRS issued a notice providing general information on the tax treatment of NFTs as collectibles and requesting public comments on various aspects of NFT taxation.
An NFT is a token issued via a blockchain that represents something unique such as digital art, music, or a collectible trading card. The NFT phenomenon has been promoted as a new way to monetize content in an age when various forms of art can be copied, pasted, and sent around the internet with a few clicks. Fans are rewarded with the ability to prove their patronage to a particular artist, while the creators gain access to a new source of revenue via the original sale of the tokens—and potentially a percentage of future sales.
When it comes to taxes, NFTs can be complicated because they can be viewed through a number of different lenses. Creators are generating new digital assets out of thin air, crypto market participants are day-trading them, and platforms like OpenSea are building marketplaces to trade them.
The IRS intends to use “look-through analysis” to determine whether NFTs should be treated as collectibles under the tax code. That means NFTs that are associated with materials that would traditionally be deemed collectibles will also be considered collectibles. “For example, a gem is a collectible under section 408(m); therefore, an NFT that certifies ownership of a gem is a collectible,” the IRS said.
The Treasury Department and the IRS are seeking comments on how NFTs function at a technical level and how that may affect their assignment as collectibles under the law.
“The notice specifically asks for help defining ‘NFT’ for tax purposes, which gives a rare chance for the industry to give direct comments to a regulator on a key issue,” said Joshua Garcia, partner at legal advisory and consulting firm Ketsal.
“This is good for crypto. Regulators should be engaging in this type of outreach on a more frequent basis. This gives a clear path for anyone with a vested interest in the taxation of their NFTs to try to control their own taxes," he said.
What Does it Mean for NFTs to Be Taxed as Collectibles?
NFTs were among the darlings of the crypto bull market that came to an end in 2021, peaking with the sale of digital artist Pak’s The Merge for $91.8 million late that year. NFT sales volume reportedly stood at $24.7 billion in 2022, a shade under $25.1 billion the prior year.
For NFT collectors and traders, the most relevant aspect of NFT taxation is related to potential profits. In the U.S., collectibles that are sold for a profit after being held for more than a year face a long-term capital gains tax that can vary depending on one’s income.
Long-term capital gains taxes are capped at 28% for collectibles compared with the top tax rate of 20% for most other types of assets. If held for a year or less, normal income tax rates apply.
Notably, the guidance from the IRS doesn’t include any new information for creators who sell newly issued NFTs.
According to Freeman Law Managing Member Jason Freeman, those who create NFTs for a living need to treat proceeds from NFT sales as income for tax purposes but it depends on how much of their rights they transfer with the NFT sale.
"By contrast, a limited transfer of rights would likely be treated as a license for federal tax purposes. In such circumstances, the creator would recognize royalty income, which are taxed at ordinary tax rates, but would not be able to offset such income with the basis of the NFT," wrote Freeman.
Does Classifying NFTs as Collectibles Make Sense?
Fitting new types of digital assets into existing tax codes can be difficult.
“The look-through approach makes sense and future guidance from the IRS that will include factors on when the associated right or asset resembles a collectible will be well received,” said Nicholas Mowbray, Counsel at law firm BakerHostetler. “There are a number of areas where taxpayers desperately need guidance and this is one of them.”
However, it’s also clear there’s plenty of work to be done when it comes to finalizing the tax classifications of NFTs. “There are still a number of open questions relating to NFTs and how they are treated for federal income tax purposes,” said Mowbray. “I would welcome guidance on how creators or dealers of NFTs should be treated for federal income tax purposes. For example, can they take the position that the NFTs are not capital assets or collectibles?”