How Should NFTs Be Taxed? The IRS Is Asking the Public to Weigh In

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The Internal Revenue Service (IRS) looks likely to begin taxing some NFTs in line with tangible collectible assets, such as works of art, precious metals, and rare coins.

In a notice released on March 21 titled “Treatment of certain nonfungible tokens as collectibles,” the IRS lays the ground for collectible NFTs that are sold after being held for more than 12 months to be subject to a 28 percent capital gains tax. The IRS generally places a maximum 20 percent rate on other “non-collectible” investments.

The five-page document provides the IRS’s definition of an NFT, the blockchain, and tokens. It calls on the general public to submit comments on the treatment of NFTs as collectibles through June 19. Among its questions, it asks if there might be further definitions of NFTs that might be relevant; what factors might categorize a digital artwork as a collectible; and how should additional NFT utility or ownership rights be considered.

At the time of writing, five comments have been submitted.

“Overall, I think the approach the IRS has outlined is logical given the nature of NFTs, it’s great the IRS is seeking public comment” Patrick Camuso, a CPA specialising in digital asset accounting told Artnet. The effective date of this guidance is among the issues it needs to address, Camuso notes, so too coordination between states, the Treasury, and the IRS. “Many states are issuing guidance related to NFT sales tax,” Camuso said, “it would be practical to develop a consistent set of terminology and definitions.”

The notice is the latest in a gradual push by the IRS to increase scrutiny over digital assets. In 2014, it determined that virtual currencies would be treated as property and has broadened its questioning in recent years. This notice marks an attempt to give equal clarity over the tax status of NFTs.

Bored Ape Yacht Club collection in OpenSea displayed on a phone screen. Photo: Jakub Porzycki/NurPhoto via Getty Images.

One area requiring further explanation is in distinguishing between different types of NFTs. An NFT, as a token on the blockchain that can be connected to a range of assets or rights, is not inherently a collectible. Though NFTs have been popularized by digital art, they are used in everything from ticketing to virtual real estate to authenticating a physical item.

The IRS says it plans to use a “look-through analysis” in assessing NFTs, meaning it will judge if the NFT’s connected right or asset is a collectible as existing tax law defines it. The IRS chooses a gem as its example, stating that since a gem is a collectible, an NFT certifying ownership of a gem is also a collectible.

A further complication the IRS will need to clarify surrounds NFTs that provide both an asset and utility. “How should a taxpayer report a gain on a sale of an NFT like a Bored Ape that is a digital representation of an Ape, but also gives the owner access to an exclusive club?” Nik Fahrer, a CPA at Forvis who specializes in digital assets, told Artnet News. “Is the determination of an NFT as a collectible all or nothing?”

Another more fundamental question surrounds labelling certain NFTs as collectibles in the first place. In the late 1990s, policymakers lowered taxes on stocks, but kept the 28 percent rate for collectibles arguing that high-value art, fine wine, rare coins, and the like were mainly owned by the wealthy. Does that logic hold true for NFTs?

 

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