NFTs are all the rage. Know the tax implications of buying and selling non fungible tokens before tax time.

NFTs, or non-fungible tokens, are the latest craze in both the art world and the cryptocurrency scene. They provide a way for creators to sell their digital art by mining them as tokens, as a sort of virtual currency, but differentiated from cryptocurrencies because they are kept or traded rather than used as a form of payment.

Traded on a cryptocurrency blockchain, the value of some NFTs has shot up dramatically, attracting interest from investors and drawing many artists to create tokens of their own. However, you may be concerned about how jumping into the burgeoning market for NFTs could affect your tax obligations.

What is an NFT?

In essence, NFTs or non-fungible tokens provide a certificate that the purchaser owns the piece of digital art that they purchased. This does not mean that they necessarily own the rights to the piece unless they were bundled in as part of the transaction. When non-fungible tokens are created on the blockchain, they typically point to an address where the artwork is stored, and NFTs themselves indicate that the purchaser did buy the virtual item in question.

Cryptocurrencies are designed to be fungible; that is, each bitcoin, litecoin or Ethereum token can be exchanged for another, much like one dollar or Euro can be exchanged for another. NFTs are non-fungible or unique; each one indicates a separate piece of digital art or another virtual item. One of the more popular forms of NFTs has been sets of related but distinct characters or images, each one unique. From Gucci Ghosts to Cryptopunks, these tradeable and unique digital assets have become virtual collectibles or trading cards.

Major artists and corporations are jumping into the market for NFTs, leading to widespread media interest as well as a surge of new inventors and creators. The National Basketball Association launched online collectibles called Top Shot, based on the blockchain and sold as NFTs. Digital artists like Beeple have sold their own non-fungible tokens for up to $69 million, with major auction houses joining in the virtual market.

Artists may see selling NFTs as a way to sustain their livelihoods as well as breaking through into a bigger audience, as investors have come to crowd the space looking for the next big trade. However, taxation is a factor to keep in mind. Like all income-generating activities and investments, understanding the tax implications of NFT trading can help prevent confusion later down the road.

How are NFTs taxed?

In general, NFTs are taxed in much the same way that typical cryptocurrency investments are, whether they are fungible or non-fungible. Artists and creators would report their proceeds for sales of their NFTs as ordinary income, much as if they had sold a piece of tangible art or an online commission to an interested buyer. On the other hand, investors may be responsible for capital gains taxes when they make a profit by trading or selling their digital assets.

On your regular Form 1040, make sure to select “Yes” to the question about whether you received, sold, set, exchanged or otherwise acquired any financial interest in a virtual currency. You can provide more details about your NFT-related transactions in the accompanying schedules and forms.

When you sell NFTs for cryptocurrency, purchase NFTs with fungible cryptocurrency, or trade NFTs for other NFTs, all of these may be considered a taxable event.

It is important to note here that, to date, the Internal Revenue Service has not issued a ruling on how NFTs will be treated. While the IRS has produced extensive guidelines for cryptocurrency transactions, the agency has not specified how these will relate to NFTs. At present, they may be handled in much the same way as cryptocurrency. This means that they would be taxed as property at the appropriate long-term or short-term capital gains tax rate, depending on your income and the length of time you held the property.

However, in the future, as the NFT market continues to develop, the IRS could determine that these tokens should be treated like other collectibles, such as physical items like stamps, old coins or antiques. In this case, they could be taxed at the higher collectibles rate of 28% for high earners. High earners are single filers with over $441,450 of taxable income or married filers with over $496,000 of taxable income. You may wish to speak to a tax professional about whether your NFTs should be considered collectibles or property to ensure accuracy in your tax filings.

Let’s explore the implications further for both creators and investors.

Tax Treatment for Artists and Creators – Ordinary Income

Artists and creators may have the most straightforward tax obligations regarding selling and marketing NFTs. After Beeple’s record-breaking $69 million sale and widespread coverage, many artists have put their own money into minting NFTs of their work. When you mine or mint NFTs, this is not considered a taxable event. However, selling NFTs on one of the marketplaces, like Rarible, Nifty Gateway or Open Sea, created for the purpose, is. When you sell your NFTs for cryptocurrency like bitcoin or Ethereum, you will need to pay taxes on the profits you make.

Profits from your sales of NFTs will be considered income, just like the income that you make from selling other types of digital or tangible art. It will be taxed at the tax rate for your income, which can vary between 10 and 37% based on your overall annual income. In general, you can treat the sale of non-fungible tokens much like getting paid in cryptocurrency for a regular piece of artwork off of the blockchain. Like other types of art sales for self-employed artists and creators, you will need to pay the 15.3% self-employment tax on these proceeds.

As with other forms of art sales, you can also deduct business expenses, such as the costs associated with minting and listing NFTs, from your taxes. In essence, consider NFTs as another type of form or marketplace for the sale of your art.

Tax Treatment for Investors – Capital Gains

nft capital gains

Investors have several more taxable situations to keep in mind when trading NFTs. Many investors are already in the cryptocurrency market, and selling and trading NFTs will often be treated similarly to other types of crypto-based investment with the gain or loss on an NFT trade treated as capital gains. As an example, if you paid $20,000 in Ethereum at that time for a non-fungible token and then sold it for $30,000 in ETH later on, you would have capital gains of $10,000. The same is true if you trade your NFTs for other NFTs. If you bought one non-fungible token for an Ethereum valued at $5,000 at the time and later trade it for another valued at $7,500, you would have taxable capital gains of $2,500.

If you hold your NFTs for over one year, they will be taxed at the long term capital gains rate, which ranges from 0 to 20% based on your overall income. However, if you hold them for less than a year, they are subject to short term capital gains rates, equivalent to your regular income tax rates.

Additionally, when you buy non-fungible tokens with your cryptocurrency, you may be considered disposing of the cryptocurrency itself, and you can be taxed on the capital gains (or losses) that you incurred from the sale of your tokens. Most frequently, transactions for non-fungible tokens take place in Ethereum.

If your Ethereum has grown in value from your initial purchase, you may be responsible for short term capital gains or long term capital gains taxes on the appreciated value of the cryptocurrency from the time that you bought it. You would owe taxes at either the short-term rate or the long-term rate depending on how long you had held the cryptocurrency before buying NFTs with it.

You may also be interested in potentially donating NFTs to a charity. By donating NFTs, a form of intangible property, you may be entitled to a fair market value deduction, subject to income-based limitations, on your taxes for the year. You can also carry forward excess contributions above the deduction taken this year into future tax years. Unlike traditional donations of physical art, NFTs are an intangible form of property, so you do not need to show that the charity’s goals are related to artwork in order to maximize your deduction to full fair market value. Your tax professional may advise you about the most advantageous way to report donations of NFTs based on your income and other priorities.

Can I write off losses?

Capital losses can be deducted up to the amount of capital gains in a given tax period, in addition to $3,000 in deductions against other income accrued during that time. Additional capital losses can be carried forward to future tax years. This is the case for investments in general, including cryptocurrency investments. This means that capital losses from cryptocurrency sales are deductible.

However, hobby losses or capital losses from the sale of items for personal use may not be deducted. Investors who purchase art to profit from future sales rather than for personal enjoyment may deduct their capital losses from those transactions, and the taxpayer should be able to prove their investment or profit motive. While most investors in the market for NFTs can clearly demonstrate that they are entering the space for financial gain, it is good to keep records and other documentation that can show that you are an investor. This can help to ensure that your capital losses from any unprofitable transactions in NFTs can be deducted from your tax return.

NFT Tax Forms

Artists and creators would report their income from NFTs, like their other income from art sales on Schedule C (Profit or Loss From Business) or on the applicable business tax return (Form 1120, 1120S or Form 1065). Creators can deduct their relevant business expenses necessary for their work, such as auction and platform fees, transaction costs, subscription fees and other costs associated with making and selling NFTs.

On the other hand, investors can use Form 8949 (Sales and Other Dispositions of Capital Assets) and Schedule D (Capital Gains and Losses). Here, you would report the disposal of your cryptocurrency for purchasing NFTs or the profits that you made from selling or trading your NFTs later on. If your non-fungible token transactions should be considered collectibles trading as a high earner, enter code C in column F of Form 8949 to designate that item as a collectible sale.

Conclusion – Get help from a pro at Picnic Tax

The market for NFTs is booming. Whether you are planning to get involved as a creator or an investor, keep the tax implications in mind when deciding your next steps. It is also important to ensure that all of your transactions in non-fungible tokens are properly tracked and recorded, especially as platforms for trading NFTs may not offer 1099 forms or other documentation of cost basis or tax calculations. By keeping records of your own, you can help to ensure your later filings are correct.

At Picnic Tax, we match you with a trained CPA to address your specific concerns and needs when filing your taxes. Our service is an especially good fit for people with complex tax situations, such as non-fungible token investors, cryptocurrency enthusiasts and self-employed artists. With advance pricing agreed upon, you will know what your tax assistance will cost, and you will receive professional support from a qualified accountant throughout the process. Picnic Tax can help you find peace of mind when filing your tax returns as a creator or investor in NFTs.