An outline of the tax effects of NFT on NFT originators, collectors, investors, and traders.
NFTs have taken over the cryptocurrency markets. According to NonFungible, sales of NFTs are up 3491% (about 2 billion) in just the past two months! International brands, digital artists and famous personalities entering the world of NFT are the driving force behind the boom in NFT collectibles buying:
And the list goes on….
However, most NFT builders and aggregators might consider their buying or selling activities like this:
- A creator sells a product (NFT) for money (ETH)
- A collector buys a product (NFT) with money (ETH).
In fact, this is not how the IRS (the federal agency responsible for collecting taxes in the United States) would consider this trade for tax purposes! Since NFTs consider themselves crypto assets, the IRS views it as a crypto-to-crypto trade:
- Creator Selling Cryptocurrency (NFT) for Cryptocurrency (ETH)
- A collector buys cryptocurrency (NFT) with cryptocurrency (ETH)
This means that you have to pay taxes on the sale (gain on the NFT buying and selling price), as well as on the purchase (the gain or loss on the sale of ETH).
Disclaimer: Regulations in the crypto field are changing rapidly. This article may be out of date when you read it – it moves so fast! Let us know if something needs updating through our chat support in the bottom right corner. This is not professional accounting advice and one should consult a CPA for advice on appropriate NFT tax rates.
What are non-fungible tokens (NFTs)?
Digital tokens stored on the blockchain network are called NFTs. The token represents a digital or physical asset.
For example: If you own real estate, you will also have a legal document on paper that confirms your ownership of the asset. Now imagine that the contents of this legal document are written into token and stored as token on the blockchain network. This is the NFT (digital code) for your property!
Various assets – collectibles, digital arts, in-game assets, albums, event tickets, domain names, property records of physical assets, videos, photos, music, text, event tweets – can be minted as NFTs and sold in the marketplace.
Why are these digital tokens called non-fungible tokens (NFTs)?
A thing can be replaced when one of its units can be replaced by a similar element. For example: You can exchange a $1,000 bill for ten $100 bills.
In general, cryptocurrencies can be exchanged. For example: at today’s prices, you can exchange 13.29 ETH for 1 BTC.
However, NFTs are called non-replaceable because one unit of an NFT cannot be replaced by one unit of another NFT. For example: One unit of your property cannot be exchanged for one unit of some other property. Simply because their size, cost and other attributes vary greatly.
Therefore, NFT cannot be used as a currency. It is considered a crypto-asset because it works on blockchain technology.
When do I owe taxes on NFTs?
The IRS has not yet issued specific tax guidance for the NFT. However, since NFT is considered a “crypto asset”, any transactions involving NFT will be considered a crypto-to-crypto transaction by the IRS.
In this sense, NFT trades will be subject to the same tax laws as crypto transactions. Capital gains and losses must be reported for the following taxable NFT activities:
- Buy NFT with exchangeable cryptocurrency
- Trading an NFT against another NFT
- Sell (Sell) NFT Cryptocurrency
However, the creation of an NFT is not a taxable event. Read the tax implications of NFT creators here
How do you calculate capital gains and losses on NFT activities?
Gains and losses are calculated by taking the paper price difference between the purchase price of the NFT and the price at which it was sold.
If you have used a redeemable cryptocurrency such as Ether to purchase NFT, you are “getting rid” of that cryptocurrency. Therefore, you will also have to record the difference between the purchase price of the cryptocurrency and the price available to calculate the profit or loss on it.
Let us understand with an example:
Buying NFT with Ether (ETH):
Adam buys 3 Ethereum cryptocurrency when ETH equals $1,000 (total purchase price of $3000). Let’s say he originally bought 3 ETH over 2 years ago when ETH was worth $500 (total purchase price of $1500). This means that he held 3 ETH for two years, during which time he incurred capital gains from the increase in the value of ETH.
Capital Gain = Total Purchase Price of NFT – Total Purchase Price of Ether
= $3,000 – $1,500 = $1,500
Selling NFT for Ether (ETH):
Three months later, cryptocurrency started trending on Twitter and suddenly there was a huge demand for it. Adam decided to take advantage of this and listed the cryptocurrency for sale for 2 ETH – worth $2,500 each at the time. Within minutes, someone had purchased it from him for a total price of $5,000. But remember, he bought it for only $3,000. Therefore, he is responsible for paying capital gains tax on the profit.
Capital Gains = Total Sales Price of the NFT – Total Purchase Price of the NFT = $5000 – $3,000 = $2000
Total Capital Gains
= Capital gain from buying NFT + Capital gain from selling NFT = $1,500 + $2,000 = $3,500
Adam will be liable to pay the total capital gains tax on $3,500.
Note: You must also add and subtract the gas fees paid to buy and sell NFTs respectively.
What is the tax rate for NFTs?
The tax rate on NFTs depends on the following factors:
- Short and long term capital gains
- Whether NFTs are treated as “collectibles” by the IRS
short term capital gain miceE:
If “NFT” is sold or “Cryptocurrency is disposed of to buy NFT” in Less than a year after I bought it, the profit made on the “sale” or “disposition” will be treated as a short-term capital gain and will be taxed at The same rate as the individual income tax bracket.
Long-Term Capital Gain Rate (OR):
If the NFT is sold or the cryptocurrency is disposed of to buy the NFT After more than a year of buying it, the profit made on the “sale” or “disposal” will be treated as Regular capital gains tax rates, and he Based on the file holder’s income level but up to a maximum of 20%.
Collectible Capital Gains Tax Rate:
As mentioned earlier, the IRS has not issued specific tax guidelines for the NFT. However, “any work of art, stamps or coins” is treated as a “collectible capital asset” under IRC section 408(m)(2).
This could mean that “CryptoKitties, CryptoPunks, and BoredApe will likely be treated as “collectibles.” If this Collectibles sold out over a year after purchase, the profit made on the sale is taxed at a price of A The capital gains tax rate for holdings is 28%.
For example: If Adam buys CryptoPunk for the equivalent of $750, but after 18 months trades it for BoredApe for the equivalent of $1,000, he is liable to pay a 28% tax on the $250 capital gains. Compounded with many similar deals, his transactions can amount to complex and unexpectedly high tax obligations.
Please consult a tax professional for advice on classification of holdings and appropriate tax rates for NFTs.
Tax implications for NFT originators:
NFT creators are artists who design NFTs and put them up for sale in markets like SuperRare, Nifty Gateway, OpenSea, etc.
Although the creation of an NFT is not a taxable event, income earned from the sale of its NFTs is taxable. It must be reported as ordinary income and will also be subject to self-employment taxes.
If you are a builder of an NFT by profession, you can also deduct normal and necessary business expenses to offset your taxable income.
Please consult a tax professional for advice on the appropriate tax rate for NFTs.
Whether you are creating, investing, trading or flipping NFTs, it is essential to understand the tax implications of your transactions. NFT Markets does not provide cost basis information on the original purchase price of the “cryptocurrency you get rid of” and the “NFT you sell”.
You will have to keep logs of both manually – the encryption used to purchase NFT and the NFT itself. The more transactions you make, the more complicated it is to track prices and calculate profit or loss.
You can simplify the process with crypto tax software like Bear.tax. You will just have to upload all your trades and the software will calculate your profit or loss and create your tax forms.
What does the future hold?
The world of NFT is constantly evolving and the introduction of new concepts and game may change how things are taxed. Follow us to stay informed!
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