- The IRS plans to tax non-fungible tokens as collectibles, the agency said in a statement Monday.
- Collectibles have a 28% long-term capital gains rate. Other assets like stocks and cryptocurrency generally carry a federal rate capped at 20%.
- NFTs are digital assets that have been gaining popularity in recent years, although investor enthusiasm waned in 2022.
- The IRS intends to use a “look-through analysis” to determine whether an NFT is a collector’s item. After a public comment period, it will issue final guidance.
Digital artist FEWOCiOUS is auctioning five NFT artworks and five physical paintings and drawings at Christie’s on June 28, 2021 in New York.
Noam Galai | Getty Images Entertainment | Getty Images
The IRS said it plans to tax some non-fungible tokens, or NFTs, as collectibles resembling art or gemstones — an approach that would tax wealthy owners’ profits more heavily compared to assets like stocks, real estate and cryptocurrencies.
The federal government levies taxes on collectibles held for more than a year at a top rate of 28%. It generally charges a maximum rate of 20% on other investments.
In a statement Monday, the IRS said it intends to issue guidance on treating certain NFTs as collectibles.
NFTs are essentially unique digital assets that can go beyond digital art to include sycg as such like tweets and gifs. Sometimes they also give owners a right in relation to a non-digital asset, e.g. B. the right to attend an event with a ticket or to certify ownership of a physical item.
The IRS has asked the public for comments, which are due by June 19.
“The IRS hasn’t said anything about NFTs until now,” said Shehan Chandrasekera, an accountant and head of tax strategy at CoinTracker. “This is sort of half a guide because it’s not finished yet.”
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NFT enthusiasm has increased in recent years along with the popularity of cryptocurrencies like Bitcoin.
However, that energy has since cratered. According to NonFungible.com, NFT volume fell 77% to $1.7 billion in Q3 2022 from $7.4 billion in Q2. Assets like stocks and bonds have also seen a broad market decline over the past year.
The IRS plans to use a “look-through analysis” to determine whether an NFT is a collector’s item.
Basically, an assessment is made as to whether the right or asset associated with the NFT is a collector’s item within the meaning of the current definition in the Tax Code – and if so, the NFT is also a collector’s item.
“NFTs can represent anything, literally anything,” said Chandrasekera. “The IRS says taxation depends on what it represents.”
STEFANI REYNOLDS/AFP via Getty Images
Section 408(m) of the Federal Tax Code defines a collectible as tangible personal property, such as a B. Works of art; carpet or antique; metal or precious stone; stamp or coin; or alcoholic drink.
Here’s an example of how the IRS would conduct a “look through” analysis: Since a gemstone is a clearly defined collector’s item, an NFT certifying ownership of a gemstone is also a collector’s item for tax purposes, the agency said.
Conversely, a right to use or develop a “property” in a virtual environment is generally non-collectible. An NFT offering a right to use or develop this virtual property is also generally not a collectible, the IRS said.
The IRS will use this look-through analysis until issuing NFT guidance in the coming months.
“The [guidance] This is the right time for tax returns,” said Troy Lewis, associate professor of accounting and tax at Brigham Young University. “As you get closer to tax day, maybe you should think about it.”
This year, the tax deadline for most Americans is April 18th.
“The IRS has clearly signaled, ‘Until we give you something else, this is how we see life,” Lewis added.
Investors pay capital gains tax when they sell an asset. The tax is due on the seller’s profit.
Short-term capital gains apply to assets held for one year or less. The profit from these sales is taxed at the usual income tax rates that apply to wages, for example. (There are seven marginal tax rates ranging from 10% to 37%.)
Long-term capital gains apply to assets that are sold after more than a year of ownership. These tax rates are generally lower than ordinary income tax rates.
NFTs can represent anything, literally anything. The IRS says taxation depends on what it represents.
Shehan Chandrasekera
Accountant and Head of Tax Strategy at CoinTracker
Stocks and cryptocurrency have a 20% cap for high-income taxpayers. (Less wealthy people pay 0% or 15%.)
But collectibles – which are typically owned by the super-rich – are subject to a different tax regime. You will be taxed at a maximum of 28%.
Their structure is also different: collectibles are taxed at the ordinary income tax rate, up to 28%. This differs from the three-tier system (0%, 15% and 20%) for stocks.
Simply put, high-income Americans pay a higher tax rate on collectibles.
Taxpayers generally can’t keep collectibles in an individual retirement account, which is tax-privileged, Lewis said.
The most recent IRS filing supports this notion, indicating that an NFT categorized as collectible cannot be purchased from these retirement accounts without potentially incurring income taxes and penalties.
Cars on display at a 2011 car show in Carmel, California.
David Paul Morris/Bloomberg via Getty Images
The IRS guidelines are “a serious step forward” for taxpayers and tax practitioners, said Lewis, who owns an accounting firm in Draper, Utah.
It’s also creative in how it takes old tax laws for tangible collectibles and applies them to a new digital asset in the modern world, he said.
However, there are still some gray areas as the notion of what constitutes a collectible isn’t always black and white.
“They don’t really address the difficult issue per se,” Lewis said of the IRS filing. “What a collector’s item is is still a little unclear.”
For example, consider a rare car someone keeps in their garage, Lewis said. That person might treat the car as a collector’s item. Now imagine another person has the same vehicle but drives it to work every day. Is the vehicle a collector’s item or more of a means of transport? What is similar to an antique desk that someone uses in their daily life?
Whether (and to what extent) a digital file constitutes a “work of art” is also somewhat unclear, the IRS said in its NFT filing. The Authority is inviting input on this issue and a number of other issues related to NFT taxation.