Welcome to our in-depth blog on the NFT 2023 tax legislation! If you’re a fan of
digital art, a collector, or an investor, you’ve probably heard about Non-Fungible
Tokens (NFTs). However, when it comes to taxes, things may become more
complicated. As NFTs gain popularity, governments worldwide enact legislation to
guarantee that these digital assets are appropriately taxed.
So, take your virtual passport and join us in 2023 as we explore the enigma of NFT
taxation. Prepare to stay educated, compliant, and one step ahead of the
competition!
What is an NFT?
Non-fungible tokens are now a widespread issue in the digital world! Consider this: a
one-of-a-kind cryptographic token that can store any digital media asset, such as a
work of art, a song, or a film. It’s like owning a one-of-a-kind digital artwork!
Blockchains like Ethereum, Solana, and Cardano serve as the underlying
technology for NFTs.
To get your hands on an NFT, you’ll need to use the native currency of the
blockchain it’s built on, like Ether (ETH) for Ethereum. But fear not; NFT
marketplaces like OpenSea and Magic Eden make buying, selling, and trading these
digital treasures easy!
IRS Guidance on NFTs
The IRS intended to offer guidelines on taxing specified NFTs on March 21, 2023.
Notice 2023-27 is the agency’s first public document. According to the Notice, NFT is
a unique digital identity that enables the owner to confirm the legitimacy and ownership of a corresponding right or asset. It goes on to say that NFTs can give
holders access to digital data and non-digital rights and support, such as digital
music, trading cards, concert attendance, or physical object ownership.
Earnings from owning an NFT, such as airdropped tokens, staking awards, and any
yield or return, will be treated as ordinary income and subject to conventional income
tax rates.
The Notice also addresses the issue of whether NFTs are collectible. If they did,
profits on NFTs identified as such would be subject to a higher rate of capital gains
tax (up to a maximum rate of 28%).
The Internal Revenue Code (Code) governs the taxation of collectibles, which
include works of art, carpets, antiquities, metals, jewels, stamps, and any other
tangible personal property designated by rules.
Here’s the recent Notice by IRS.
“NFTs can represent anything, literally anything. The IRS is saying taxation depends
on what it represents.” – Shehan Chandrasekera (ACCOUNTANT AND HEAD OF TAX
STRATEGY AT COINTRACKER)
Are NFTs taxable?
Yes, profits from the selling of NFTs are taxable. It is critical to highlight that there
are no legal loopholes or techniques to avoid tax repercussions while selling NFTs.
For tax reasons, the Internal Revenue Service (IRS) regards NFTs as property,
similar to how cryptocurrencies like Bitcoin or Ethereum are taxed. This implies that
any gains or losses from selling NFTs must be reported on your tax return. The rate
of taxes is determined by the length of time you owned the NFT and your total
taxable income.
While the fundamental approach to NFT taxes is similar to that of other forms of
property, there are various subtleties and complications to be aware of. Examine
some of the most typical concerns, complexities, and queries concerning NFT
taxation.
What is the tax rate for NFTs?
The IRS states that the tax treatment of NFTs is determined by various criteria and is
controlled by standard tax rules applicable to property transactions. NFTs, like other
types of cryptocurrency, are typically considered property.
They are subject to short-term and long-term capital gains restrictions and tax rates
ranging from 10% to 37%. Individual circumstances and applicable tax legislation
may affect the specific tax consequences of digital tokens.
How to calculate your NFT taxes?
- Determine your NFT gains or losses: Calculate the similaritries and
differences between the purchase price and the selling price of your NFT.
This will give you capital gains or losses for tax purposes.
- Classify your gains or losses: Holding the NFT for one year or less before
selling is considered a short-term capital gain or loss. If you have held it for
over a year, it is regarded as a long-term capital gain or loss.
- Apply the appropriate tax rates: Short-term capital gains are usually taxed at
the ordinary income tax rate, whereas the long-term capital gains are taxed at
lower rates based on your income level.
- Consider deductions and credits: You may be eligible for certain deductions or
credits that can offset your NFT gains, such as capital losses from other
investments or business expenses related to your NFT activities.
For all you creators out there here are NFT Taxes for Creators
As an NFT developer, you must recognize that crypto transactions involving your
digital assets are taxable. Your sales will be recorded and taxed differently
depending on whether you are a hobbyist, tradesperson, or company owner.
If you are classified as a hobbyist, you will be unable to deduct expenditures
connected to the creation of your NFTs and will be required to pay taxes on the
gross sales revenues of your NFTs. Your earnings, however, will not be subject to
self-employment tax.
If categorized as a trade or business, you can capitalize and deduct costs for
generating your NFTs and required business expenditures such as utilities, supplies,
and rent.
The net taxable income could also be subject to self-employment tax, at a rate of
15.3%, in addition to federal and state income tax, depending on your entity type.
Events when NFT’s can be taxed?
o Purchasing NFTs: When you buy a digital token, you may need to pay sales
tax, if applicable in your jurisdiction. The sales tax rate and regulations vary by
location.
o Selling NFTs: When you sell a digital token, you might be subjected to capital
gains tax on the difference between the selling price or the share issued and
the purchase price if the NFT has increased in value since you acquired it.
The tax rate will depend on various factors, such as your holding period and
income level.
o Swapping NFTs: If you exchange one digital token for another digital token, it
may trigger a taxable event, as it could be considered a sale or an exchange
of property/real estate for tax purposes. The fair market value of the digital
tokens at the time of the swap will be used to calculate any potential tax
obligations.
o Using NFTs for business purposes: If you use digital tokens in your
business, such as for promotional purposes or as part of a digital asset
trading business, you may be subject to income tax on any gains or losses
related to the digital tokens.
o Receiving NFTs as gifts or income: If you receive digital tokens as gifts or
as part of your income, they may be subject to gift tax or income tax,
respectively, based on their market value at the time of receipt.
Which NFT transactions are exempt from taxes?
As per current tax regulations, most NFT transactions are subject to taxation.
However, certain circumstances may be where NFT transactions could be
considered non-taxable. Here are some possible scenarios:
- Gifts: If you receive an NFT as a gift from someone, it may not be subject to
immediate taxation. - Inherited NFTs: If you inherit tokens through an estate or as part of an
inheritance, the digital tokens may receive a stepped-up basis, which means
that the value of the Non Fungible Tokens for tax purposes would be based
on the original market value at the time of inheritance. - Donating an NFT: Tax treatment of donating NFTs can be complex and
depends on various factors, including the fair market value of the NFT during
the time of the donation and the specific tax laws and regulations of your
jurisdiction.
What are collectibles?
Collectibles are valuable items because of their scarcity, historical relevance, or
aesthetic appeal. Art, antiques, coins, stamps, precious metals, vintage autos, and
sports memorabilia are all examples of collectibles.
Collectors frequently buy, sell, or exchange these artifacts for future appreciation in
value or personal delight.
Are NFTs considered collectibles for tax purposes?
Given the unusual nature of NFTs, which frequently depict digital art, tax
practitioners have speculated whether these digital tokens may be categorized as
collectibles under US tax law. Net long-term profits on the sale of NFTs would be
subject to a maximum tax rate of 28% instead of 20% if categorized as collectibles.
However, the tax rules do not designate NFTs as collectibles as of March 2023. The
IRS now employs a “look-through analysis” to evaluate whether an NFT should be
classified as a collectible depending on whether the connected right or asset fulfills
the tax code’s definition.
Reducing NFT taxes: Tips and strategies
● Hold NFTs for more than one year: If you hold onto your NFTs for longer
than one year before selling them, any gains will be termed as long-term
capital gains, which are generally taxed at lower rates than short-term capital
gains.
● Consider charitable donations: Donating Non-Fungible Tokens to qualified
charitable organizations can result in a tax deduction for the fair market value
of the donated NFT.
● Take advantage of tax deductions: If you are a creator and use digital
tokens for business purposes, you may be able to deduct certain expenses
related to your NFT activities, such as transaction fees or marketing
expenses.
Taxing capital gains and NFTs
Profits from selling the assets that have gained value over time are subject to capital
gains tax. This also applies to non-financial transactions (NFTs), where purchasing
cheap and selling high can result in taxable gains while buying high and selling low
can result in taxable losses.
Notably, almost all of the NFT transactions, whether selling, trading, or cashing out,
are taxed. The time a digital token is held influences how it is taxed, with short-term
profits taxed at ordinary income rates (10-37% according to the 2023 IRS tax
brackets) and long-term gains taxed at reduced rates (0-20% depending on the
value).
According to the IRS threshold for 2023, the tax deduction on net capital gains for
most persons is typically 15%. However, for further information on capital gains
taxes relating to NFTs, check Form 8949.
For Example:
Let’s say you purchased an NFT artwork for $1,000 and sold it for $5,000. The $4,000
difference between the purchase and sale prices is a capital gain.
If you held the NFT for less than a year before selling it, it would be considered your
short-term capital gain and taxed at your ordinary income tax rate. For example, if
your usual income tax rate is 30%, you would owe $1,200 in capital gains tax on the
$4,000 gain.
If you held the NFT for more than a year before selling it, it would be considered as a
long term capital gain and taxed at lower capital gains tax rates. For example, if the
long-term capital gains tax rate is 20%, you would owe $800 in capital gains tax on the
$4,000 gain.
Here’s an easy way to track Non Fungible Tokens
A simple way to keep track of Non-Fungible Tokens is to build a spreadsheet or
digital record to enter pertinent information—for example, the buy, selling,
acquisition, and sale dates for each NFT transaction. You can also provide additional
tax-related details, such as transaction or petrol fees.
Alternatively, you may utilize online specialized NFT monitoring tools or software to
automatically track and record your NFT activities, calculate capital gains or losses,
and provide complete tax reports. These tools can help shorten the process and
guarantee that your NFTs are accurately tracked for tax purposes.
