Non-Fungible Tokens (NFTs) are booming. In what seemed like just a few weeks, NFTs have taken the art world by storm. Meanwhile, more and more clients reaching out to us about the tax implications they should be aware if they create NFTs or invest in NFTs.
NFTs are digital representations of assets. 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.
If you are an investor who buy or sell NFTs, you may be subject to capital gain tax. The IRS has not issued any specific tax guidance on NFTs but in most cases, the NFTs should be categorized as collectibles under the tax code § 408(m)(2)(A)).
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.
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.