It seems that NFTs have become all the rage in the last couple of years, but the practice of investors using art to “hide” their assets to minimize tax liability is nothing new. However, don’t think that being an NFT creator or collector means you can avoid paying taxes on any profits you make. While the Internal Revenue Service has yet to define rules that are specific to NFTs, in 2014 they released Notice 2014-21, 2014-16 I.R.B. 938, which defines digital assets as property for federal tax purposes, and subject to the same rules as other types of assets.
What is an NFT?
NFT stands for “non-fungible token.” It is a digital (usually artistic) asset that is minted on a decentralized blockchain network, such as Ethereum or Tezos. When this happens, the digital creation is “stamped” with a token that cannot be duplicated, making the NFT unique. An easy analogy is to think of it as similar to owning the original signed painting by an artist rather than a print of it. Each NFT is unique; they are not interchangeable. While you can easily copy or share the image, only the NFT is going to have the creator’s token attached.
NFTs have become popular among artists and collectors, and many have sold or resold for thousands or even millions of dollars. Some of the most famous and profitable examples of NFT projects include CrytoKitties, CrytoPunks and the Bored Ape Yacht Club. Even celebrities are getting into the NFT craze. Sports figures and musicians such as Shikira and Snoop Dogg have gotten involved in creating and selling these digital collectibles.
When Do You Need to Report NFTs on Your Tax Return?
What events are considered taxable will depend on whether you are an NFT creator or collector. If you are a professional creator, minting an NFT is a taxable event. This means that the “gas” fee you paid to mint the NFT can be deducted as a business expense, and any profit you make from selling it is counted as ordinary income. In addition, any resale royalties would be taxable as well.
If you are a trader or collector, the IRS classifies NFTs as collectibles, and are bound under the same rules as valuable tangible items such as art, precious gems, and antiques. Any gains made from selling an NFT for more than you purchased it for will be taxed as short-term or long-term gains, depending on how long you held onto the asset before selling it. However, you can also claim losses from NFT transactions as well.
How to Report Gains From NFTs
While NFTs are taxed as ordinary assets for creators, they are treated as capital assets for collectors. Capital gains and losses, including those related to NFTs, are reconciled using the IRS Form 8949, and reported on Form 1040 using Schedule D. If you sold an NFT, be sure to enter the code “C” (for collectible) in column (f). Assets that you have had for a year or more or taxed at the long-term capital gains rate of 28%, regardless of your income level. Any held for less than a year are taxed as short-term gains, which is equal to your ordinary income tax rate.
Potential Consequences For Not Reporting
Don’t think that you can hide your NFT profits from the IRS. As their popularity has grown, the IRS has been focusing on the enforcement of tax payments for digital currency gains such as those from NFTs, and has been targeting those who fail to comply with audits and cryptocurrency tax fraud investigations. While blockchain transactions were once anonymous, it has now become easier to identify the parties involved. Be sure to avoid the risk of fines or criminal charges by ensuring your NFT gains are properly reported.