The popularity of Non-fungible tokens (NFTs) has exploded in recent months. NFTs, as they are called, are cryptographic tokens that represent something unique. This could be something like digital art or a digital collectible item.
NFTs have started selling for record prices. Yesterday, a digital work of art sold for a jaw-dropping $69 million. So how are these NFTs taxed?
NFT Tax Overview
NFTs are taxed as property just like other cryptocurrencies (e.g. bitcoin, ether, etc.). The taxable treatment varies depending on whether you are a creator or an investor in NFTs.
NFT creators are taxed at the time they sell NFTs. Say Sarah creates a rare digital collectible art piece and mints an NFT. She then sells it for two ether (ETH), valued at $2,000. She would report $2,000 as ordinary income. If she is in the trade or business of creating NFTs, she can also deduct business related expenses to reduce the tax bill.
Investors are individuals who buy and sell NFTs for speculative purposes. Most people fall into this category. For NFT investors, taxes work very similar to crypto trading. Both purchasing an NFT using a cryptocurrency (like ether) and selling an NFT (for cryptocurrency, fiat, or any other good/service), triggers a taxable event subject to capital gains tax.
Say, Tyler purchased an NFT valued at $1,000 (1 ETH) in January 2021. To make the purchase, he uses 1 ETH purchased at $200 several years ago. When he purchases the NFT in January, he incurs a long-term capital gain of $800 ($1,000 - $200). This is considered long-term because he held the ETH for more than 12 months before disposing of it to purchase the NFT. Long-term capital gains are taxed at either 0%, 15% or 20% tax rates. The cost basis of the NFT purchased would be $1,000. Note: just like with other cryptocurrencies, trading one cryptocurrency for another (including NFTs) triggered a taxable event — not just when you cash out to fiat currency.
If Tyler were to sell this NFT in April 2021 for $10,000, he would have a short-term capital gain of $9,000 ($10,000 - $1,000). In this case, the gain is short-term because he held on to the NFT for less than 12 months before selling. Short-term gains are taxed at your ordinary income tax rates.
You can use CoinTracker’s manual entry feature on the Transaction page to track the cost basis of NFTs and calculate gains when they are sold.
Additional taxes for high income earners
It’s important to note that some NFTs could fall under the IRS definition of “collectibles” (§ 408(m)(2)). This leads to a somewhat unfavorable tax treatment on long-term NFT capital gains for high income earners (single filers with over $441,450 of taxable income & married filers with over $496,000 of taxable income). These high income earners are subject to a 28% tax rate on collectible gains vs. the highest 20% tax rate on regular cryptocurrency and stock long-term capital gains. Taxpayers who are below these income thresholds won’t see a difference in tax rates between NFT gains and regular cryptocurrency gains.
If you have any questions or comments about crypto taxes let us know on Twitter @CoinTracker.
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Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.