Whether you’re an artist creating and selling NFTs or an investor interested in buying and trading NFTs for profit, it’s important to understand NFT taxes to avoid a surprise tax bill at the end of the year.
What started years ago with a blockchain-based platform for collecting and breeding one-of-a-kind digital cats, CryptoKitties, is now transforming the way artists, musicians, sports fans, and celebrities buy and sell original creations. This trend we’re referring to is the rise of NFTs.
An NFT, or non-fungible token, is a digital certificate of ownership rights built on the blockchain, typically Ethereum. Unlike fungible tokens like bitcoin or litecoin, NFTs are one-of-a-kind tokens that have a unique value and cannot be duplicated. For example, you could swap one bitcoin for another bitcoin, each worth the same value, but since NFTs are unique, it is not possible to swap one out for another.
You don’t have to look far to find examples of NFTs. From Beeple selling an NFT for $69 million to NBA Top Shot’s online collectibles trading platform selling moments in NBA history, NFTs are making headlines across the globe.
For artists, musicians, and anyone creating one-of-a-kind content, converting your digital masterpiece into an NFT is a way to record your ownership on the digital ledger and ensure authenticity. And many speculators are banking on a huge money-making opportunity from buying and trading these digital assets.
Among all the hype and excitement, though, it can be easy to forget about a key element that comes into play with every sale and transaction around NFTs: taxes. Whether you’re an artist creating and selling NFTs or an investor interested in buying and trading NFTs for profit, it’s important to understand NFT taxes to avoid a surprise tax bill at the end of the year.
In most cases, yes, NFTs (non-fungible tokens) are subject to the same tax laws as fungible cryptocurrencies. If you’re an artist who earned money from selling an NFT, you would need to report the proceeds as income on your tax return. And if you invest in NFTs, any profits earned through sales or trades will be taxed as property and subject to the capital gains tax.
The most common taxable NFT activities include:
For those creating NFTs, the taxes are fairly straightforward. However, if not considering the tax implications that accompany digital art, it’s not uncommon to face an unwelcome tax bill when filing tax returns. Let’s look at the primary tax considerations for creators:
These profits are considered income and will be taxed at your ordinary income tax rate, which varies from 10% - 37%. This is a similar tax treatment to getting paid in crypto, or mining or staking crypto for that matter. Additionally, this income is subject to self-employment taxes, at a rate of 15.3%.
For NFT traders and investors, there’s a few more likely taxable situations to consider. The following NFT activities will incur a capital gains tax:
When you purchase an NFT using a cryptocurrency, this constitutes a disposal of the cryptocurrency and will incur a capital gain or loss. For instance, if you bought an NFT trading card on OpenSea with appreciated Ethereum, you would incur a capital gain and would need to pay taxes on this capital gain. Depending on how long you held the Ethereum before using it to buy the NFT, you would be subject to either the long term or short term capital gains tax rate.
On the other hand, if you bought the NFT trading card with depreciated Ethereum, you would incur a capital loss and could use this to offset other capital gains and therefore lower your tax liability.
Trading one NFT for another NFT also triggers a taxable event. For instance, if you bought an NFT for $2,000 of ETH and traded it for another NFT a few months later worth $3,500 of ETH you would incur a taxable capital gain of $1,500.
Whenever you sell an NFT, you incur a capital gain or loss. For example, if you bought an NFT for $10,000 of ETH (this is your cost-basis) and then sold it for $15,000 of ETH, you would incur a taxable capital gain of $5,000.
It’s important to note that the IRS has not taken a formal stance on the tax treatment of NFTs to this date. It is possible that NFTs could receive the same tax treatment as cryptocurrency, which would be taxed as property with a long-term capital gains tax rate that varies from 0 - 20% based on your income. Alternatively, NFTs could receive similar tax treatment to stamps, antiques, or trading cards, and be taxed at the collectibles tax rate, which is significantly higher at 28%.
However, this difference only comes into question when assets are held for over one year. With that being said, any NFTs sold after a holding period of less than one year will be subject to short-term capital gains tax rates (which equals ordinary income tax rates), regardless of whether they’re viewed as property or collectibles.
Whether you’re creating or investing in NFTs, it’s important to be aware of the tax implications. The more transactions you do, the more complicated tracking and calculating NFT taxes gets. Most NFT platforms do not issue 1099 forms with cost basis information, so it’s in your best interest to keep records of both the cryptocurrency used to purchase NFTs and the actual NFTs.
You can simplify this process by using a cryptocurrency tax automation software like TaxBit to calculate your gains and losses, generate your tax forms, and view your tax liability in real-time.