Non-Fungible Tokens (NFTs) had their boom period in the covid days but are still quite popular, and many taxpayers still need assistance with related tax strategy & reporting. In fact, more and more clients reaching out to us about the tax implications of creating NFTs or investing in NFTs.
Those creating NFTs:
A NFT is a unique digital identifier and is used to certify authenticity and ownership of an associated right or asset. If you are artist who creates NFTs and sells in marketplace, you are considered in a trade or business. The income you earn from selling NFTs are subject to ordinary income tax and self-employment tax. Like other artists, you can write off expenses related to the business to offset the income.
Those investing in NFTs:
If you are an investor who buy or sell NFTs, you may be subject to capital gain tax. According to the latest IRS news release IR-2023-50, March 21, 2023, NFTs are generally classified as collectibles under the Internal Revenue Code § 408(m)(2)(A)) until the further guidance is issued.
When you purchase the NFTs, you don’t have to buy with crypto but in most cases, this is how it is practically done. The purchase itself can be a taxable because you are disposing of an asset to buy another asset. Whether it is short-term or long-term depends on how long you have held the crypto that you used to purchase the NFTs. Selling NFTs can also be taxable event.
When you sell NFTs, it Is considered a disposal of assets held for investment purposes, so the transaction will generate capital gain or loss. If it is short-term capital gain, it is taxed at your marginal ordinary income tax rate. If it is long-term capital gain, the gain may be subject to a higher 28% maximum rate as the IRS considers them as collectibles. With capital gain, you may need to pay quarterly estimated tax to avoid the underpayment penalty.
In summary
If you are not sure how to handle NFTs on your tax returns, we are happy to assist you with these any any other related topic:
- How to report capital gains
- Do you need to use any type of aggregator software for your 8949 as per the IRS?
- What other similar clients have done in your situation, how to avoid common mistakes, and how to avoid IRS audit
- What recordkeeping requirements exist
- How to strategize and optimize your tax profile
- Information on quarterly taxes, trading professionally, and other topics
This is only a brief overview of the NFTs tax implications. If you need further consultation or help with calculating tax liability from NFTs, please contact Dimov Tax at the form below. We are happy to assist.
