As non-fungible tokens (NFTs) gain momentum, taxpayers should be aware of related tax obligations
Wolters Kluwer Tax & Accounting looks at the possible tax implications of creation of or investment in non-fungible tokens.
What: Non-fungible tokens (NFTs) are unique digitized assets stored on a digital ledger. The use of a digital ledger makes them somewhat similar to cryptocurrencies. However, cryptocurrencies are fungible and can be exchanged with each other, like a paper currency. NFTs are not readily exchanged with other NFTs. They can range from a digital baseball card to a digital work of art that sold for over $69 million. The Internal Revenue Service (IRS) has not yet specifically addressed the taxation of NFTs. Therefore, the tax issues should at present be addressed by analogy to the tax treatment of cryptocurrencies and intangible property.
Why: The creation and sale of NFTs has grown into a multimillion-dollar industry in just a couple of years. As more individuals and businesses get involved in creating NFTs and investing in NFTs, taxpayers will need to struggle to understand their tax treatment until specific guidance addressing NFTs is issued by the IRS. Some of the tax issues include the following:
- Creators. Creation of an NFT would generally not be a taxable event. The sale of created NFTs likely results in the treatment of the sale proceeds as ordinary income, similar to tangible created works
- Investors. Investors may be subject to capital gains on the sale or exchange of NFTs, with the short and long-term holding period requirements similar to other capital assets
- Collectibles. Unlike cryptocurrencies, NFTs may be subject to the higher capital gains tax on collectibles
- Losses. While an investor may be entitled to capital loss deductions on the sale of NFTs subject to the net capital loss deduction limitations, a holder of NFTs for personal enjoyment rather than investment may not be entitled to any capital loss deduction under the hobby loss rules
- Businesses. An individual or entity engaged in the business of dealing with NFTs may have a greater ability to deduct net business losses against other income
- Volatility. The significant swings in value of NFTs that have so far been experienced makes the potential for gains or losses even more unpredictable than for many other assets
- Form 1040 Virtual Currency Question. An individual who has acquired, sold, or exchanged NFTs may have to respond “Yes” to the cryptocurrency question on Form 1040
- Charitable donations. The tax deductions available for donations of NFTs to charity may be influenced by the charitable purposes of the recipient and the intangible character of the NFTs
- Tax reporting. NFTs may be subject to the new tax reporting rules for cryptocurrencies under the Infrastructure Investment and Jobs Act
Who: Tax expert Mark Luscombe, JD, LL.M, CPA, Principal Federal Tax Analyst, for Wolters Kluwer Tax & Accounting, can help discuss the possible tax treatment of non-fungible tokens.
PLEASE NOTE: These materials are designed to provide accurate and authoritative information in regard to the subject matter covered. The information is provided with the understanding that Wolters Kluwer Tax & Accounting is not engaged in rendering tax advice or accounting, legal, tax or other professional service.
Contact: To arrange an interview with Mark Luscombe or other federal and state tax experts from Wolters Kluwer Tax & Accounting on this or any other tax-related topics, please contact Bart Lipinski.
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