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Non-fungible tokens (NFTs) have seen an increase in popularity over the past few months.
Many people may have seen the letters “NFT” appear in their timeline and thought to themselves, “What the hell is this?” and “How does this help me?”
Well, NFTs are tokens created using blockchain technology to link a non-fungible token to a digital asset that cannot be copied. The token represents something unique on the blockchain and can be used to digitize assets and data.
Fungiability refers to a good or an asset that has the potential to be exchanged for other goods or assets of the same kind.
Non-fungible assets create a simple medium of exchange or trade because the fungible nature of assets means they are of equal value.
Money is a prime example. If I lend you a $100 bill, it would be perfectly OK to pay me a different $100 bill, or even pay me five $20 bills because the total U.S. dollar value is equal to each other and is mutually exchangeable. On the other hand, if I give you a unique piece of art, and you want to return a different piece by a different artist, this will not be acceptable because these assets have their own unique characteristics that can add or subtract value. In this example, one artist might be more desirable or they might use different patterns in the way they complement the piece.
Looking at this from a crypto perspective, your ETH or BTC has the same value as someone else’s ETH or BTC, as there is a market for digital assets which is similar in nature to our monetary example. The individual or entity that owned the token or previously mined the token is irrelevant.
On the other hand, NFT is not like BTC or ETH because NFT is rare and rare. Usually, NFTs are indivisible and most importantly, NFTs are unique. This allows the NFT owner to certify the token’s authenticity on a permanent basis.
NFTs have experienced an explosion in popularity over the past year, creating a new NFT economy.
For example, the NBA, NBPA, and Dapper Labs recently came together to create the NBA Top Shot. NBA Top Shot is a collectible game that allows Top Shot players to collect their favorite moments and highlights in a digital form they can own forever. Some of the most famous players like Lebron James and Kevin Durant have sold for more than $50,000.
In addition, just last week, a new ETH project called Hashmasks was launched. The project has sold a collection of 16,384 unique digital images created by more than 70 artists around the world. The founders of the project ended up selling the art pieces for nearly $9 million. Some of the art has been sold for 100 ETH each ($160,000 at the time of writing). Like all NFTs, collectible art pieces have a market value based on how rare and unique they are, but Hashmasks also have the potential to name a few. The Hashmasks project contains a native code, the Name Change Code (NCT), which gives the individual or company that holds their Hashmask art a unique name that is visible to the public and stored permanently.
NFTs are currently used in the DeFi space. Armor, a decentralized coverage brokerage project written by blockchain-based insurance Nexus Mutual uses arNFT. arNFT is a non-fungible token that can be minted and held to protect the user, can be sold by the user in the marketplace, or the user can store it to earn fees in both ETH and ARMOR tokens.
As mentioned earlier, NFTs are currently used in the technical and collection field.
NFTs are very popular in gaming as well. In the future, we may see the use of NFTs for real estate.
With NFT backed by real estate assets, we may see title deeds appear on the blockchain through a fully automated and digitized process. Real property can be encoded on the blockchain and the NFT can be used to prove that an individual or entity actually owns a plot of land or a structure. Blockchain technology and NFTs can create a more efficient transfer of ownership while reducing legal disputes.
As we discussed last week, in accordance with IRS guidelines (notice 2014-21), the IRS treat cryptocurrencies (they use the term “virtual currencies”) such as Bitcoin, Ethereum, AAVE, and UNI as property for tax purposes. This property classification is used for both typical tokens as well as non-replaceable tokens.
NFTs are unique and rare, making it easy to trace an NFT to a specific wallet address. The way the sale of an NFT is treated for tax purposes depends on the nature of the business. The NFT tax treatment of a numbered asset will effectively reflect the way a physical copy of the property will be treated for tax purposes.
Using Hashmasks to illustrate an example:
Artists involved in selling the pieces for ETH will receive regular income at the time of the sale as the artists create and sell the artworks.
The final disposition by a purchaser of a Hashmask may have different tax treatments depending on whether the purchaser is considered an amateur, an investor or a trader.
Hobbyists (those who buy art without thinking whether it will be a profitable investment) will get to process capital gains for gains, but losses are not allowed.
Investors (those who buy and sell artwork in the hope that the assets will rise for a profit) will have to process capital gains and losses.
Merchants (those who buy and sell art as a trade or business) are taxed in the same way as any ordinary business, with income taxed at ordinary income rates.
Most cryptocurrency investors will buy NFTs as a way of investing, and when selling, they will have a capital gain or loss.
At Taxing Cryptocurrency, we have filed tax returns for cryptocurrency dating back to 2013. We have cleared millions of transactions on the blockchain across many exchanges and platforms and have submitted hundreds of tax returns. The more complex crypto taxation and your trading situation, the more likely it is that you will need tips and advice on cryptocurrency taxes. Whether we assist our clients with the settlement process, or strategize and implement our plans for potential disposition, Crypto Taxes has the expertise and experience to guide our clients through the complexities that the crypto market imposes on their crypto tax.