NFT Taxes: The Expert Guide in 2023
The use of NFTs to buy and sell unique digital goods like digital art and collectibles has exploded in popularity. However, there are tax repercussions when purchasing and selling NFTs in the US, just like with other cryptocurrency transactions. In this regularly updated guide on NFT taxes, our tax experts explain everything about how NFTs are taxed in the US, along with information on how to report capital gains tax on NFT sales and any income derived from owning an NFT.
Last Updated: May 3, 2023
What is an NFT?
NFT stands for 'non-fungible token' and refers to a one-of-a-kind cryptographic token, to which you can embed any digital media file such as a picture, song, or movie. Although they have a wide range of potential use cases, most projects to date have been digital art collections.
NFTs are unique digital assets that run on top of a blockchain. The blockchain acts as the underlying infrastructure that powers NFTs, similar to an operating system. The most common blockchains for NFTs include Ethereum, Solana, and Cardano. To purchase NFTs, one must typically use the blockchain's native currency. For example, if you want to buy an NFT on the Ethereum network, you’ll need Ether (ETH) to complete the transaction and pay any associated fees. NFT marketplaces like Open Sea and Magic Eden facilitate trading. These platforms allow users to buy, sell, and trade NFTs.
Are NFTs Taxed?
Yes, NFTs are currently subject to capital gains (CGT) and ordinary income tax. NFTs fall within the definition of a virtual currency of the Internal Revenue Service (IRS) Notice 2014-21 and FAQs on virtual currencies. The regulators have updated the instructions to Form 1040 to explicitly state that NFTs fall within the scope of a “digital asset,” which means they are also taxed as property subject to capital gains tax. It's possible that the IRS will eventually classify NFTs as collectibles, but until then, NFT holders should stay up-to-date with any new guidance and consult a tax professional when necessary.
How NFT Taxes Work in the US
NFT taxes in the US vary depending on whether you’re a seller, buyer, or creator. As an NFT holder or investor, you should know that NFTs are currently subject to income and capital gains tax. NFTs are taxed as property, and gains or losses from the disposition of NFTs are reported on Form 8949.
Buying an NFT with fiat currency is not taxable because this is considered an investment in property. However, if you buy an NFT using cryptocurrencies (which is common on platforms like Open Sea and Magic Eden), any gains or losses from disposing of the cryptocurrency used to purchase the NFT will be taxed. This is similar to trading one cryptocurrency for another.
On the other hand, any earnings from holding an NFT, such as airdropped tokens, staking rewards, and any type of yield or return, will be considered ordinary income and is subject to ordinary income tax rates. The valuation of such earnings can often prove difficult as many of these tokens have very low liquidity and value, and many are even scams. While we have no explicit guidance on these situations, since these assets have little to no value, taxpayers generally shouldn’t worry as long as they’re careful not to interact with such assets.
How does the IRS classify NFTs?
The IRS currently classifies NFTs as digital assets. In the 2022 version of Form 1040, the term "virtual currency" changes to "digital assets" to cover a wider range. The instructions include non-fungible tokens in this definition, saying that "digital assets" are any digital representation of value that is recorded using secure cryptographic technology like distributed ledgers.
Are NFTs classified as collectibles?
Due to the nature of NFTs, many of them representing digital art, tax practitioners have wondered whether non-fungible tokens should be treated as collectibles under US tax law. This would mean that net long-term gains from selling NFTs treated as collectibles would be taxed at a maximum rate of 28%, as opposed to 20%.
As of March 2023, the tax code does not affirmatively treat NFTs as collectibles. However, the Treasury Department and the IRS have requested comments and issued temporary guidance. Until further notice, the IRS will determine if an NFT should be treated as a collectible by using a "look-through analysis.” This means that an NFT is treated as a collectible if the associated right or asset falls under the definition of collectible in the tax code.
What are the current definitions of a collectible?
Under Internal Revenue Code section 408(m)(2), a collectible means any work of art, rug or antique, metal or gem, stamp or coin, alcoholic beverage, or other tangible personal property specified by the Secretary. Section 408(m)(3) provides certain exemptions for gold, silver, platinum, or state-issued currency, as well as certain gold, silver, platinum, or palladium bullions. If you have an NFT that you believe is a collectible, consult your tax advisor.
NFT Taxable Events
Buying an NFT
Buying an NFT with crypto will be a taxable event due to the sale of the crypto you are using to purchase the NFT. If you buy an NFT with fiat currency (USD), this won’t be a taxable event.
Certain protocols enable direct swapping or trading of NFTs, much like exchanging cryptocurrencies. This is a taxable event because you are selling the original asset you had. CGT is applicable.
Selling an NFT
Selling an NFT in a marketplace or exchange is subject to capital gains tax. an NFT for either fiat or crypto is a taxable event. Keep in mind that tax rates vary depending on the holding period. You’re subject to short-term rates if you owned the NFT for less than a year. However, if you exceed this timeframe, your case falls under long-term taxation.
It is crucial to add that you may also use a capital loss from the sale of an NFT to offset other gains. The Accointing platform can easily help to identify all your transactions and harvest losses.
NFT holders can generate different forms of revenue. For example, you may benefit from an NFT airdrop thanks to simply holding another NFT, or you may receive tokens in exchange for staking your NFT holdings. Both cases are subject to tax according to IRS guidelines.
How are NFT Airdrops Taxed?
Receiving an airdrop of an NFT or token as a reward for holding an NFT, translates into a taxable income based on the fair market value (FMV) of the NFT or token at the moment it is received.
NFT Staking Tax
Earning tokens from staking an NFT is taxed the same as staking cryptocurrency; these rewards are categorized as income based on the fair market value of the tokens at the time of receipt and, therefore, subject to ordinary income tax.
Play-to-Earn Games Tax
Play-to-earn (P2E) games exploded in popularity during the last bull run, some of the big names being Axie Infinity and Thetan Arena. These games offer you the opportunity to earn rewards in the form of NFTs from playing the game. In this case, NFTs are subject to the ordinary income tax, the same as if you were earning cryptocurrency.
Non-taxable NFT transactions
Transferring NFTs between any of your wallets doesn't represent a taxable event. Any internal transactions will be automatically detected by the Accointing platform, sparing you from paying taxes on them.
Minting an NFT
Creating an NFT does not result in taxable consequences, except when there is a fee for its creation. The act of minting becomes taxable when there is a cost involved. Whatever crypto you used to mint (1 ETH, 1 SOL, etc), then this is your cost basis, in much the same way as buying. Always consult with a tax professional to be clear on your tax obligations.
Donating an NFT
When it comes to NFTs, the IRS has not yet issued specific guidance on whether a donation to a qualified charitable organization would be deductible like donations of other appreciated property. In theory, if you want to donate a BAYC, it should be the same as donating some crypto, given that it's a "virtual currency" as per the IRS FAQs. It would then appear to be subject to the same requirements as donating crypto. Keep in mind that the fair market value of an NFT can be difficult to determine, which could create challenges for taxpayers and charitable organizations alike.
Donating an NFT to a qualified 501(c)(3) organization would not be considered a taxable disposal for an investor in the US. Furthermore, donating NFTs can also reduce taxable income for taxpayers who itemize deductions. If you have held the asset for over a year (long-term), you can deduct the fair market value of the NFT without paying tax on the appreciation. If your NFT is short-term, your deduction is limited to the lower of cost or fair market value at the time of donation.
It's important to note that there are specific regulations to consider when donating appreciated property, which taxpayers should be familiar with. For instance, to be eligible for the full market value deduction, the property must satisfy the IRS related use rule, which states that the donee must use the property for the same function as its basis for exemption under section 501. This can be problematic with NFT donations if the recipient does not have a plan for how to use the property. Furthermore, if the donation is for $5,000 or more, donors must file Form 8283 and provide a qualified appraisal on the property donated. Due to the many complexities and uncertainties with NFT donations, you should consult with a tax advisor to fully understand the tax implications of donating your NFT.
How to Reduce your NFT Taxes
In some cases, crypto investors can make use of several strategies that help save money on NFT taxes.
Can I Burn an NFT to Realize a Loss?
If you happen to be a victim of a scam NFT project or rug pull, you may be able to realize a loss by sending it to a burn address (0x000000000000000000000000000000000000dEaD). Therefore, if the burning renders the NFT unusable and removes it from circulation, you may experience a CGT event that results in a capital loss. However, the IRS has not provided any clear guidance on this topic, please consult with your tax advisor before taking any decision.
Can I sell my NFTs for Tax Loss Harvesting?
Yes! If you have NFTs that have decreased in value since you acquired them, you can sell them on any popular exchange and realize a taxable loss. Likewise, you can also use a burn address and realize a loss in exchange for $0 proceeds. Please be mindful if any NFTs owned are scams and whether you want to be the person selling them to someone else, or if you should just burn them.
How to Calculate your NFT Taxes?
To calculate your NFT Gains/Losses, you can follow these rules:
- Taxable gain or loss = Proceeds from sale – cost basis
- Proceeds from sale: The amount of fiat or crypto (in USD) received for the NFT sold
Your cost basis = the amount paid for the NFT in USD when paid in fiat, or the USD equivalent of the crypto paid for the NFT + fees
Using a crypto tax tool like Accointing for calculating your taxes can greatly simplify the process. You only need to connect all your wallets in which you hold your NFTs. From here, Accointing will automatically calculate any gain, loss, income, and internal transactions accordingly. Please consider that if you hold NFTs on an unsupported blockchain, you'll have to add it as a custom currency and manually input the cost basis.
Accurate records are essential for calculating capital gains tax and reporting NFT transactions on tax forms. It is vital to document the cost basis, acquisition date, sales date, and any associated fees or commissions for each NFT. Providing guidance on maintaining meticulous records would be beneficial. The good news is that Accointing automatically saves this information in your portfolio when you import data, getting a tax report is as easy as following four steps: identifying unknown currencies, internal transactions, transfer classification, and solving missing funds issues.
How to File Your NFT Taxes?
Remember that NFTs are taxed as property, and gains or losses from the disposition of NFTs are reported on Form 8949. Each NFT is considered a different asset for tax purposes.
If you’re using Accointing for your crypto taxes, all the required information will be on the PDF report generated by the tool. In case you need further assistance, please use the Crypto Tax Filing Guide. This guide covers the next steps and provides you with all the necessary guidance on how to file your crypto and NFT taxes.
Don’t hesitate to check out our regularly updated 2023 Ultimate Crypto Tax Guide for detailed explanations on taxation on crypto.
Tax rates on NFTs
Collectible tax rate
Certain NFTs may be treated as collectibles for tax purposes by the IRS. Collectibles are distinct type of capital asset that is subject to a higher tax rate than other assets. If your NFT is classified as a collectible, the maximum tax rate is 28%, which is higher than long-term capital gains tax rates. It's worth mentioning that this higher rate is only applicable to long-term sales of assets held for over a year. Due to limited guidance by the IRS, it's advisable to determine the category of your NFT on a case-by-case basis. If you're unsure about the classification of your NFT, it's best to consult a tax professional and provide them with specific details about your situation.
Short-term capital gains rate
If you sell an NFT within 12 months of acquiring it, you'll be subject to the short-term capital gains tax rate, which can range from 10% to 37% of your gains, based on your situation.
Long-term capital gains rate
If your NFTs are not classified as collectibles, they will be subject to the standard long-term capital gains tax rates if held for 12 months or more before disposal. The tax rate for long-term capital gains can vary from 0% to 20%, depending on your level of income.
Are NFT Royalties Taxable?
As an NFT creator or owner, receiving recurring royalties for each sale is considered taxable income. For instance, if the person attaches a 1% royalty to an NFT artwork, then 1% of each trade subsequent to the sale of that NFT will be categorized as income as soon as it arrives in the creator's wallet. The income earned from NFT royalties is considered ordinary income and must be reported to the IRS, with its value equivalent to the USD value of the cryptocurrency (ETH, SOL, DAI, USDC, etc) at the time of receipt. It's crucial for NFT creators to keep accurate records of all their earnings and consult with a tax professional to ensure they are fulfilling their tax obligations
NFT Taxes for Creators
If you're an NFT creator, be aware that any crypto transactions linked to your digital assets are taxable events. You can list your art for sale on marketplaces such as OpenSea and SuperRare, whether you're a hobbyist or a professional digital artist selling NFTs for a living. How your sales are reported and taxed will depend on whether you are a hobbyist or in a trade or business. If you don’t qualify as a trade or business, you are considered a hobbyist, which means you cannot deduct expenses related to creating your NFTs, have to pay tax on the gross sales proceeds of your NFTs, but your income will not be subject to self-employment tax.
If you are in a trade or business, on the other hand, you can capitalize and deduct costs related to creating your NFTs, deduct any necessary business expenses (such as utilities, supplies, rent, etc), and the net taxable income could also be subject to self-employment tax, of 15.3%, in addition to any federal and state income tax, depending on the type of entity.
Regardless, any proceeds received from selling your NFTs will be considered your gross revenue based on the value of the coins received. From there, depending on your classification you’ll need a different tax form (either Schedule 1, line 8 for hobbyists or the proper business tax form). As mentioned before, business owners will pay tax on the net taxable income from the business activity after deducting allowable expenses, whereas hobbyists will pay tax on the total revenue, subject to federal tax rates ranging from 10% to 37%, similar to short-term capital gains. If the NFTs are sold for cryptocurrency, it is critical to track the coins as they will be subject to capital gains tax upon disposition in all cases.
The information contained in this guide, including any supplemental materials, is for general information purposes and does not constitute financial, investment, legal, or tax advice. The present content is not intended as a thorough, in-depth analysis, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. Please consult your tax advisor.