April 5, 2022

Tax Treatment on NFTs: How it Works

Written by Team Cointelli Updated April 5, 2022

Non-fungible tokens (NFTs) skyrocketed in popularity in 2021.  

Suddenly, it felt like everyone was buying and selling these original creations, from cartoon apes to some of the first memes ever made. Celebrities, artists, influencers, entrepreneurs, and ordinary people were all dabbling in the one-of-a-kind tokens, which hit $25 billion in sales throughout the year.   

Because NFTs are such a new commodity to many and come along with little regulation from the Internal Revenue Service (IRS), guidance on taxation is few and slight. But like all fungible cryptocurrencies, taxpayers may need to file this digital asset too, depending on specific factors. 
 

First, let’s dive into what NFTs are!

An NFT is a one-of-a-kind token that is built on a blockchain and cannot be duplicated, therefore giving it a unique value compared to other digital currencies. The tokens hold distinctive identification codes and metadata that distinguish them from one another. So, while traders can swap one bitcoin for another because they have the same value and are thus identical, NFTs cannot be traded because they do not hold similar worth to each other. In other words, NFTs cannot be replicated. 

NFT collections have soared in the past year. From Jack Dorsey’s first-ever tweet to Nyan Cat GIFs, any unique artifact on the internet can now be bought and sold in a matter of minutes. This gives individuals—especially those who are creating and buying the exclusive content—access to their own digital asset that cannot be duplicated with any other currency. These consumers are drawn to NFTs because they offer that rare quality that is unmatched with other assets, and in return, can yield huge money-making breaks. 

Yet, while traders might get wrapped up in the appeal, hype, and fanfare of NFTs, it’s important to understand the tax rules that come with buying and selling the digital assets. 

 

If you dabbled in NFTs, do you have to file taxes on it? 

Yes—but like crypto, this only applies with certain taxable NFT activities. If a taxpayer invested in NFTs, any profits earned through sales or trades will be taxed as property and are subject to the capital gains tax. For example, taxpayers who earned money from selling an NFT will need to report any gains as income on their tax return. Additionally, if an NFT was purchased with a fungible cryptocurrency, the taxpayer would also need to file any gain or loss on that exchange on their tax return. 

 

Next, taxpayers are divided into two groups: Creators and investors

While creating an NFT is not considered a taxable event, selling the NFT on an open marketplace is. To the creators, income from NFT sales are considered ordinary income and will be taxed as such at rates between 10% to 37%. 

The idea is like that of regular cryptocurrency where miners, stakers, and those getting paid in crypto are taxed. It’s important to note that this income is also subject to self-employment taxes, at a rate of 15.3%. 

Investors who sell NFTs are subject to tax at either short-term or long-term capital gains tax rates, depending on whether they’ve held onto the token for over or under a year. For example, if Mary purchased an NFT in July 2020 and then sold it in August 2021, she would be subject to long-term capital gains taxes. However, if the NFT was sold in May 2021 instead, the gain is short-term and therefore will be taxed at an ordinary income rate. 

Other instances that may trigger a taxable event include trading one NFT for another NFT and selling an NFT for cryptocurrency.

It’s also worth noting that high-net-worth individual taxpayers are subject to a 28% tax rate on collectable gains—which NFTs are likely considered to be—along with a 3.8% net investment income tax. 

 

Lastly, learn how to file NFTs on your taxes 

While the IRS has not taken a formal stance on the tax treatment of NFTs, it is possible that NFTs are taxed similarly or like that of cryptocurrency in the future. 

For now, creators will have to file any NFT-related income on a Schedule C form, or on an applicable business tax return such as Form 1120, 1120S, or Form 1065. On the other hand, investors should use Form 8949 and Schedule D (capital gains or losses form) to report crypto and NFT activity. 

Understanding NFTs is hard, and wrapping your head around the taxes associated with them is even tougher. At Cointelli, we can help you navigate the NFT tax space, so you can continue creating or investing in the one-of-a-kind token—worry-free. 

 

Got any crypto tax questions? Ask us on Twitter! Our co-founder & crypto tax expert Daniel @Cointelli_Dan will answer you directly!

 

DISCLAIMER: This post is for informational purposes only and should not be interpreted or relied upon as a substitute for the advice of financial, legal, or tax professionals. This content also only addresses U.S. federal income tax consequences for U.S. citizens and residents and does not address tax consequences that may be relevant to a particular person subject to special rules, such as dealers or traders. You should consult with your own financial, legal, or tax professionals to report and file your crypto taxes or make decisions on your particular circumstances. The laws, regulations, or interpretation of the existing laws could change, which may adversely affect either prospectively or retroactively. The content of this post is subject to changes.
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