[01etc] Are NFT a Tax Loophole? Essential NFT Tax Guide

In 2021, as high-profile sales of digital art and other collectibles such as CryptoPunks surged in popularity and value, non-fungible tokens, or NFTs, caught the attention of the financial and investment community.

According to CoinMaketCap, an NFT’s market cap was sized for a total of $25.5 billion last year, making it the most successful industry worth investing in.

However, as NFTs become more widely used, the NFT industry regulation and taxation questions are getting one of the most overlooked aspects to discuss.

So today we would like to discuss who and in what cases are obligated on the taxation of digital art and is possible to report on the tax return and how to limit taxes on NFTs.

Generally, are NFTs taxable?

Creating and trading NFTs are not taxable events.

However, the situation changes once you sell your NFT. What does that mean?

NFTs are considered like any other property you own.

Let’s say you are a creator of your personal NFT (maybe you are!). At the stage of the NFT creation, you are not obligated to tax report, since you are not producing any income yet. You upload your NFT on the marketplace and your NFT item was successfully sold. In this case, you must disclose profits and losses on your yearly tax return. The Internal Revenue Service, or IRS, will anticipate a portion of any virtual currency or NFT profits you make. How long you owned the asset in addition to your taxable income determines your tax rate. On the other hand, you can often write off losses to counteract capital gains.

Thus, the taxation will occur once one of the following actions happens:

Using cryptocurrencies to buy an NFT
Exchanging one NFT for another one

Let’s have a closer look at the NFT taxation depending on the position you are at.

NFT taxed for creators:

NFT creation:

An NFT creation will is not a taxable event.

Minting NFT:

Publishing an NFT on a blockchain will not be obligated on the tax reporting.

Selling NFT:

Any revenue-generating action occurring with your NFT is taxable including selling it.

Creating NFTs as a part of the self-employment or NFT dealer will be considered a tax obligation.

Making money from loyalties on NFTs:

Despite the fact that IRS, has not released any guidelines on the income you got from loyalties, it is more likely to be considered self-employment. However, it also can be considered as passive income in case of a one-off sale.

NFT taxed for investors:

When buying an NFT:

If you buy NFTs using a cryptocurrency like Ethereum, you could be establishing a completely distinct liability from the NFT itself. Because of the way the IRS has set up the regulations around crypto use, each transaction involving cryptocurrency will result in a tax report.

When selling an NFT:

You will be required to pay capital gains tax on any rise in the NFT’s value when selling it on the marketplace. Depending on how long you hold the NFT with no income-raised actions happening such as reselling, you will pay short-term rates if you owned it for a year or less. In the case of holding the NFT for more than a year, you will more likely to receive long-term rates.

Are Gifted NFTs tax liable?

If you choose to sell an NFT for a profit after receiving it as a gift, you will only be taxed once. If you are giving someone else the gifted NFT, take into consideration that American taxpayers benefit from an annual gift tax exception, which in 2022 amounts to $16,000 per beneficiary.

As of 2022, there is also a lifetime exclusion amount of about $12 million. If the total value of your gifts to one person, including NFTs, exceeds $16,000 during the calendar year, you’ll have to report the difference on your tax return.

Tips on how to limit taxes on NFTs?

As with any other item requiring ownership rights, you can save on taxation following the tips above:

- Hold NFTs for at least a year.

In 2022, rates on long-term capital gains are typically more benevolent. In the long run, you may pay 0%, 15%, or 20% depending on your income and filing status. On the other hand, short-term rates can reach 37%.

- Make your purchases with fiat money.

Paying for NFTs with cryptocurrency triggers a taxable event — not so if you pay with cash.

Bottom Line:

It can be challenging to navigate the still relatively new world of NFTs, particularly when taxes are involved. Time will tell how the IRS manages these assets in the end, but for the time being, it appears that they will be considered as property (or, in some cases, collectibles). Consult a tax expert if you’re unsure of how to incorporate NFT sales and earnings in your tax return.