How NFTs Are Taxed: The IRS Plan

Digital artist FEWOCiOUS is auctioning five NFT artworks, along with five physical paintings and drawings at Christie’s on June 28, 2021 in New York.

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The IRS said it plans to tax some non-fungible tokens, or NFTs, as collectibles akin to art or gems — an approach that would tax profits for wealthy owners at a higher rate compared to assets like stocks, real estate and cryptocurrency.

The federal government taxes holdings held for more than one year at a higher rate of 28%. It generally charges 20% higher than other investments.

in notice On Monday, the IRS said it intends to issue guidance on treating certain types of NFTs as collectibles.

NFTs are essentially unique digital assets, which can extend beyond digital art to include sycg such as Tweets and GIFs. They also sometimes grant owners a right with respect to a non-digital asset, such as the right to attend a signed event or certify ownership of a physical item.

The IRS has requested comments from the public, which is due by June 19.

said Shehan Chandrasekera, accountant and head of tax strategy at CoinTracker. “That’s kind of half of the guidance because it’s not finalized yet.”

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How the IRS plans to tax NFTs

NFT enthusiasm has swelled in recent years along with the popularity of cryptocurrencies such as bitcoin.

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However, this energy since then holes. NFT volume fell 77%, to $1.7 billion, in the third quarter of 2022 versus $7.4 billion in the second quarter, according to NonFungible.com. There was also a significant downturn in the market among assets such as stocks and bonds last year.

The IRS plans to use a “growth look analysis” to determine if the NFT is collectible.

Essentially, you’ll be judging whether the right or assets associated with the NFT are collectible as currently defined by tax law – and if so, the NFT is also collectible.

“NFT can represent anything, literally anything,” said Chandrasekera. “The IRS says taxes depend on what they represent.”

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Section 408(m) of the federal tax code defines collectibles as tangible personal property like any work of art; Rug or antique metal or jewel stamp or coin or liquor.

Here’s an example of how the IRS performs a “growth look” analysis: Because gems are clearly collectible, NFTs that certify ownership of gems are also collectible for tax purposes, the agency said.

Conversely, the right to use or develop a “plot of land” in a virtual environment is generally unclaimable. The IRS said that the NFT offering the right to use or develop that virtual plot generally could not be collected.

The IRS will use this theoretical analysis to issue guidance for the NFT in the coming months.

“this [guidance] “It’s a critical time for tax returns,” said Troy Lewis, assistant professor of accounting and taxation at Brigham Young University. “As you move towards Tax Day, you may want to think about this.”

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This year, the federal tax deadline is April 18th for most Americans.

“Obviously the IRS has indicated that until we give you something else, that’s how we look at life,” Lewis added.

How are collectibles taxed?

Investors pay capital gains tax when they sell an asset. The tax is due on the seller’s profits.

Short-term capital gains apply to assets held for a year or less. The profit on these sales is taxed at ordinary income tax rates, which apply to wages, for example. (there Seven marginal tax rates ranging from 10% to 37%).

Long-term capital gains apply to assets sold after more than a year of ownership. These tax rates are generally lower than ordinary income tax rates.

An NFT can stand for anything, literally anything. The IRS says taxes depend on what they represent.

Shihan Chandrasekera

Accountant and Head of Tax Strategy at CoinTracker

Stocks and cryptocurrencies carry a cap of 20% for high-income taxpayers. (Less wealthy individuals pay 0% or 15%).

But collectibles — which are usually owned by the ultra-rich — are subject to a different tax regime. They are taxed at a maximum rate of 28%.

Its structure is different, too: Collectibles are taxed at ordinary income tax rates, up to 28%. This differs from the three tier system (0%, 15% and 20%) for stocks.

Simply put: Americans with higher incomes pay a higher rate of tax on collectibles.

Lewis said that taxpayers generally cannot keep collectible amounts in an individual retirement account, which is tax-favorable.

A recent IRS notice supports this idea, stating that NFT classified as collectible cannot be purchased by these retirement accounts without income taxes and penalties.

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There are still some gray areas for collectibles and NFTs

Cars on display at an auto show in Carmel, California, 2011.

David Paul Morris/Bloomberg via Getty Images

Lewis, who owns an accounting firm in Draper, Utah, said the IRS guidance is “serious progress” for taxpayers and tax practitioners.

He said he is also ingenious in how he can take advantage of the old tax code for tangible collectibles and apply it to a new digital asset in the modern world.

However, there are still some gray areas since the idea of ​​what constitutes a collectible item isn’t always black and white.

“They don’t really deal with the hard case, per se,” Lewis said of the IRS notice. “What can be collected is still somewhat unstable.”

For example, Lewis said, think of a rare car that someone keeps in their garage. This person may treat the car as a collectible. Now, consider that a different person has the same car but drives it to work every day. Is the car a collectible or is it a means of transportation instead? Likewise, what about an antique desk that someone uses in their daily life?

The IRS said in its NFT notice that (and to what extent) the digital file constitutes a “work of art” is somewhat unclear. The agency is seeking input on this and a host of other questions related to NFT taxation.

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