NFTs, non-fungible tokens for long, have become extremely popular amongst several different industries, including entertainment, sports, and visual arts. An NFT is a digital certificate that shows you own a specific physical or virtual asset that may include videos, images, products, or other types of content.
Although this is an exciting new way to invest and sell products, there has been the question of, “are NFTs taxable?”. The question to that answer depends on your situation. To learn more about NFT taxes and how to write off NFTs, continue reading below.
Are NFTs Taxable?
If you’re creating an NFT, you don’t pay taxes on the NFT until it sells. This concept is the same as someone creating a painting or some form of physical art. When they sell the art piece, they receive funds after someone purchases their craft, not before. Any income received from the purchased NFT is recognized as ordinary income and is taxed accordingly.
Taxing NFTs Trades
Similar to NFT creators, NFT traders don’t owe taxes unless they sell the NFT for profit. As long as they hold the NFT and don’t sell it, they have the opportunity to sit on their unrealized gains without needing to pay any taxes.
As of yet, there is no clear guidance from the Internal Revenue System on how to treat those capital gains. Most tax professionals believe these NFTs should be treated as collectibles, while others believe they should treat it as capital gains.
If you treat them as capital gains, you will need to pay capital gain taxes on the net profits. If you realize a loss on a trade, you have the opportunity to net that against your gains. As a bonus, you can realize up to $3,000 in net capital loss and use that as an NFT tax write-off.
NFT Buyers May Be Creating Tax Liabilities
If you use a cryptocurrency to buy your NFT, there is a chance that you could be creating a tax liability. This is due to how the IRS structured its rules about crypto taxes. For example, you create a tax liability if you trade crypto for a service or an NFT.
Taxes on NFT Income and Royalties
Some NFTs have “smart contracts” which pay the original creator a royalty each time someone purchases the NFT. For example, let’s say a creator sells the NFT to one person, and three months later, that original buyer sells it to someone else.
Depending on the NFT, the creator may receive a small percentage of royalty on the second-hand sale. This could create a tax liability for the creator of the NFT.
On the other hand, this has the potential to create a taxable loss or gain for the person who sold the NFT to the second buyer, depending on the sale price of the NFT, the value received for the crypto, and the cost basis.
Some newer NFTs represent an interest in a specific asset with the potential to generate income over time. Income received from these types of NFTs is taxed at your income tax bracket level; therefore, it is treated like any other regular income.
Gifted NFTs and IRS
NFT taxation is unclear, but it gets even murkier when it comes to gifted NFTs. For example, PepsiCo. minted NFTs and gave them away for free to their consumers. Although it was free for the consumer to receive, there is still the question of tax liability.
Per their statement, they advised that each person who received the NFT should consult with their tax advisors about their own personal tax consequences. If you received an NFT as a gift, it would be best if you reached out to a reputable tax professional to help you figure out the cost basis of the NFT.
NFT Taxes and Statements
If you trade an NFT and you make a profit, you still owe taxes even if the NFT trading platform did not provide you with a 1099 for your gains. Although these Form 1099s are routinely provided by brokers and common in traditional financial markets, they are not currently required for NFTs.
Some platforms provide them, such as Coinbase, but most trading platforms don’t just yet. To report your NFT sales, you can use Form 8949.
Sales Tax on NFTs
Certain states, such as Washington state, are opening up to impose sales tax on NFTs. As of right now, Washington state’s government is looking to draft an excise tax that clarifies its position on NFT state taxes. Although this is not common across all states, it is something worth noting. In the near future, states may start to impose taxes on NFT sales.
NFT Tax Reports Based on the Seller Type
As mentioned earlier, the type of taxes imposed on an NFT differs based on who you are. For example, there are taxations on the creator side in addition to the investor side.
Creator Sales Tax
NFTs are intangible assets; therefore, their cost basis is based on the difference between the cost of creating the NFT and the amount the creator received when they sold it. The difference between the two is taxed as ordinary income, with rates graduating up to 37% in addition to applicable state income taxes.
Dealers who purposely buy and sell NFTs as part of their business practice pay ordinary income taxes when the NFT sells because, in this aspect, the NFT is your business inventory. Like NFT creators, NFT dealers have the right to deduct business expenses connected to the sale of the NFT.
This includes any cost to acquire the NFT. The net gain from the sale is taxed federally in addition to state income taxes. Dealers who buy and sell NFTs should look out for any issues with sales tax withholding.
Personal User Sales
A personal use asset is an asset that someone holds but doesn’t use for investments or in a business or trade. Individuals typically hold these assets for a hobby or recreational use. The investor’s intent determines if the NFT is used as an investment or for personal use.
Gains made from selling the NFT that is held for personal use are taxable as capital gains, but the losses on the sale are not deductible. The Medicare surtax of 3.8% shouldn’t apply to the gains made from selling the personal use NFT.
If you hold an NFT as an investment instead of in a trade, the NFT qualifies for capital loss or gain treatment upon the sale. Any short-term capital gains not offset by any other capital losses are taxed at your highest income tax rate. This can be as high as 37%.
If you are able to hold the NFT for more than one year, the gain received may be eligible for long-term capital gain. The current long-term capital gain is 20%, but if the NFT is considered a collectible, it will have a higher tax of 28%.
Regardless of whether the NFT is considered a collectible or not, the sale of the NFT held for investment is treated as net investment income. Depending on your total income, you could be subject to the Medicare surtax of 3.8%.
Should I Speak with a Tax Attorney?
Throughout this article, we mentioned that you might want to reach out to a reputable tax professional to help you navigate the tricky laws of NFTs. Although several different tax professionals are up to date with the ever-changing rules of tax laws, you may want to reach out to a tax law professional. NFT projects implicate several different federal laws, so it is crucial that you reach out to a law firm with lawyers experienced in this area of expertise.
NFTs and Additional Legal Consequences
The right tax attorney should be able to help you decipher if your project meets the SEC’s definition of a “security.” If it does, you have it exempted or registered as a security. In addition to registering the NFT (or applying for exemption), your NFT may be regulated for transfers and marketing efforts.
If you own a company that hosts employees that deal with NFTs, they must register as broker-dealers. If they give out financial advice or projections about NFTs, they may need to register as investment advisors.
It is very important to ensure that your NFT is clear of any misrepresentations and compliant. If the SEC finds you to be liable under the anti-fraud provision, you could face severe penalties.
How to Find the Right NFT Tax Attorney
If you’ve decided to partner with a tax attorney to help you navigate the complexities that are NFT tax rules, there are a few things you should look out for. For example, you first want to ensure your attorney has experience handling NFT tax laws.
Check Out Their Reviews
Although NFTs are relatively new, several different reputable NFT tax attorneys have been in business, helping their clients with NFT tax laws and how to reduce their taxes. Once you find an attorney you think you want to work with, look at their reviews.
See what other clients liked or disliked about working with the attorney. You can use websites like the Better Business Bureau or Yelp to help you gain insight on the attorney and their law firm. The best way to gauge an attorney is to reach out to them for a free consultation.
How Do I Reduce My NFT Taxes?
There are a few available strategies you can use to reduce your NFT liability. For example, a simple way to reduce your tax liability is to hold your NFT for more than twelve months. As you already know, long-term capital gain rates are much lower than short-term gain rates.
Buy with Fiat Currency
It is important to note that you incur capital gains based on the difference between the price of your coin now and when you originally received it. As a result, if you’ve held crypto for many years and you’ve seen a significant appreciation, you will most likely incur a consequential tax liability if you use that coin to buy NFTs.
To reduce this liability, you can use fiat currency. Some NFT markets allow you to buy NFTs with fiat currency. Making purchases with fiat is not considered disposal of property. This means that using this method won’t cause you to incur capital gains.
Dispose of Your NFTs in a Low-Income Year
Your ordinary income determines your tax bracket each year. To reduce their tax liability, it is not uncommon for investors to dispose of their NFTs in the years that their annual income is low.
Of course, it is best to reach out to a reputable tax professional before you conduct any of these strategies. What may work for one person won’t work for someone else.
Help with Taxes on NFTs Problems
Now that you know the answer to “are NFTs taxable?” it’s time to review your tax liability and what you can do to reduce it. NFTs are still relatively new, and the tax laws surrounding these non-fungible tokens constantly change.
To ensure that you are reducing your tax liability as much as possible, you may want to reach out to a reputable tax attorney. If you are in the business of selling, trading, or creating NFTs, it would help to have an experienced tax attorney on your side to help you with the best tax strategy for your situation.
Contact us now for more information on how to reduce your NFT liability! Our team is ready to assist you with any questions you may have.