NFT Taxes in the US - Complete Guide 2024

What are NFTs?

Non-fungible tokens (NFTs) are unique digital assets representing ownership or proof of authenticity of a wide variety of virtual and real-world items. They have significantly impacted the cryptocurrency landscape, particularly noted during the last bull market in 2021.

In the ever-evolving world of NFTs, Profile Pic (PFP) NFTs like Bored Apes and Crypto Punks have emerged as more than digital art; they're a status symbol, each with its own subculture.

The rise of NFTs isn't limited to artwork; they're integral to some of the fastest-growing games in the metaverse, enhancing virtual experiences through ownership and trade of in-game assets. As NFTs move into the mainstream, the complexities surrounding their taxation have become increasingly evident. Hobbyist investors and professional creators must navigate the intricate landscape of NFT taxes, ensuring compliance and understanding of their tax obligations.

Are NFTs Taxed By The IRS?

Yes, the Internal Revenue Service (IRS) does tax gains made from disposing of NFTs for US taxpayers just the same as it treats the same situation with other cryptocurrencies.

The IRS typically categorizes NFTs as property, aligning them with other cryptocurrencies like Bitcoin or Ethereum. However, a significant development occurred on March 21, 2023, when the IRS announced its intention to potentially treat certain NFTs as collectibles akin to art or gems. This new classification means that some NFTs might be subject to a higher tax rate of up to 28%, depending on whether the NFT is deemed a collectible under a "look-through analysis".

This analysis aims to determine whether an NFT, based on its underlying asset, falls under the collectible category as outlined in the tax code.

You must report any gains or losses from NFT transactions on your tax return for both regular property and collectibles. The specific rate you'll pay varies based on the duration you held the NFT and your overall taxable income. Fortunately, losses from NFT sales can often be deducted to offset other capital gains and up to $3,000 of income per year.

The IRS's recent guidance includes examples to clarify what might constitute a collectible. For instance, an NFT representing ownership of a physical gem would be treated as a collectible, given the underlying asset is a gem. Conversely, an NFT signifying a plot of land in a virtual environment (the metaverse) would not be considered a collectible, as it doesn't fit into the specific categories listed in section 408(m)(2) of the tax code, which includes art, antiques, metals, gems, stamps, coins, alcoholic beverages, and other specified tangible personal property.

Does The IRS Know About My NFTs?

The perception that cryptocurrency, including NFT transactions, is private and beyond the grasp of tax authorities is a prevalent myth. Many believe that the decentralized nature of blockchain means their activities are untraceable by the IRS. However, this is a misconception. The blockchain is a transparent ledger, documenting every transaction in a way that's accessible to anyone at any time. In fact, due to its permanent and open record of transactions, the blockchain is one of the least suitable platforms for concealing financial activities.

Crypto mixers, like Tornado cash, are smart contracts that pool and scrambles cryptocurrencies from multiple sources to obscure their origin and enhance privacy. Many people mistake these as a route to avoid tax, but they're not. The IRS has a history of handling complex tax evasion cases and has developed sophisticated methods to track financial activities, even those obscured through services like Tornado Cash. Engaging in such practices can lead to serious legal repercussions.

It's also crucial to remember that the IRS collaborates closely with cryptocurrency exchanges, which are required to collect Know Your Customer (KYC) information. These exchanges report significant amounts of user trading data to the IRS, including details of transactions, withdrawals, and the addresses to which funds are sent. This level of detail significantly enhances the IRS's ability to trace transactions back to individuals, even if they've used services designed to obscure the trail.

For US taxpayers dabbling in NFTs, the safest and most lawful course is to assume that the IRS will have visibility into your transactions and report them accordingly.

What NFT-Related Activities Are Taxable?

The IRS views any crypto-to-crypto transaction as taxable. The specific tax implications of your NFT activities can vary depending on whether you're classified as a hobbyist or a professional creator.

While the definitions are not entirely black and white, a hobbyist is typically someone who doesn’t mint and trade NFTs as a profession, rather they do it for fun and have income from employment or an unrelated business.

A professional creator is someone who creates, sells and/or trades NFTs professionally.

Here's how different activities are taxed for each type of individual:

What You Need to Know as a Hobbyist

Minting an NFT

Minting an NFT itself isn't taxable unless it incurs a cost. If there's a fee associated with minting — for example, if it costs 0.1 ETH to mint an NFT — this is considered a trade, and the 0.1 ETH used for minting is subject to taxation. This is similar to buying NFTs with crypto, which is covered below. Additionally, gas fees incurred during the minting process are considered taxable expenses.

Purchasing an NFT with Cryptocurrency

When you buy an NFT using cryptocurrency, you effectively dispose of that crypto. This disposal is a taxable event, and you may owe capital gains tax on any increase in the crypto's value from when you acquired it to when you used it to purchase the NFT.

Example: Suppose you use 100 ETH to buy a Crypto Punk on an NFT trading platform when ETH is trading at $3,000, totalling a spend of $300,000. If you initially acquired the ETH when it was worth $1,000 (totalling $100,000), you owe capital gains tax on the $200,000 increase in value.

Selling an NFT

If you sell an NFT, either directly or through an NFT trading platform, you're liable for capital gains tax on any NFT value increase since you acquired it. The rate depends on how long you've held the asset: less than a year incurs short-term capital gains rates, while more than a year benefits from the lower long-term rates.

Example of NFT capital gains: Imagine you bought a Milady NFT for 5 ETH when ETH was $2,000 (totalling $10,000). If you later sell it for 4 ETH when ETH is $4,000 (totalling $16,000), you've made a taxable gain of $6,000.

Trading Crypto for NFTs and Vice Versa

Because cryptocurrency is considered property by the IRS, you incur a tax liability whenever you trade crypto for an NFT or dispose of an NFT for crypto. This includes both gains and losses.

NFT Tax Loss Harvesting

If you sell an NFT at a loss, you can use that capital loss to offset other gains and possibly reduce your taxable income by up to $3,000 per year. This strategy, known as tax loss harvesting, can help mitigate your overall tax burden.

What You Need To Know as a Creator

Selling an NFT

If creating and selling NFTs is part of your business or livelihood, the NFTs are treated as inventory, and profits from sales are taxed as self-employment income. This means you'll also be subject to self-employment taxes. This tax treatment applies similarly to digital artists and NFT dealers who operate as part of a business.

Earning Royalties on an NFT

As of the latest IRS guidance, there has yet to be a specific mention regarding NFT royalty income. However, it's generally expected that royalties earned from NFTs, particularly if you're professionally minting and selling as part of a business, are treated as ordinary income. This means that you may also owe self-employment tax on these earnings in addition to regular income tax. If the royalties are derived from a one-off sale, they might be reported as passive income on Form Schedule E.

The distinction between hobbyists and professionals is crucial in determining tax obligations. For both hobbyist investors and professional creators, understanding the nuances of tax regulations is vital to ensuring compliance and optimizing your tax position. Consulting with a tax professional is highly recommended to navigate the complexities of NFT-related taxes and to keep abreast of any updates or changes in IRS policies.

Taxable Activities for Both Investors & Creators

Donating an NFT

As the NFT space matures, more artists and investors are considering donating NFTs to charitable organizations or for auctions. While donating an NFT itself isn't a taxable event, there are conditions under which the donation can offset gross income:

• The NFT must have been held for more than a year.
• The recipient must be a qualified 501(c)(3) organization.
• The NFT must be donated directly to the organization.

However, if you trade an NFT for fiat or another cryptocurrency before donating the proceeds, it's a taxable event. Therefore, to avoid tax liabilities and maximize the donation's impact, donating the NFT directly to the organization is crucial.

Note: If the NFT is auctioned for charity without being transferred first to a 501(c)(3) entity, the original owner might owe capital gains taxes on the auction proceeds, even if those proceeds are donated. Under current tax laws, you can deduct up to 60% of your adjusted gross income for certain charitable donations.

Play-to-Earn (P2E) Gaming Taxes

The advent of Web3 has brought about a new era in online gaming, where in-game assets like characters, tools, and landscapes are tokenized and can be owned and traded by players. These "play-to-earn" (P2E) games allow players to earn profits through in-game activities such as battling or trading NFTs and other crypto assets.

While the specifics can vary from one game to another, the general principle is that most actions in a P2E game are taxable because they involve crypto-to-crypto trades. Selling an in-game asset for a profit constitutes a capital gains event while earning in-game assets for participating in the game's ecosystem is likely considered income. Understanding these activities' tax implications is essential for players and creators involved in the P2E space.

What Is The NFT Tax Rate?

The tax rate for NFTs varies based on several factors, including the nature of the transaction and the duration the asset was held. As per IRS guidelines, digital assets like NFTs are treated as property, meaning general tax principles applicable to property transactions also apply to NFT transactions.

Short-Term vs. Long-Term Capital Gains

Short-Term Gains: Any profit is considered a short-term capital gain if you hold an NFT for less than a year before selling or exchanging it. Short-term gains are taxed at the same rates as your regular income, which can range from 10% to 37% as of the current tax brackets.

Long-Term Gains: If you hold an NFT for more than one year, it qualifies for long-term capital gains rates, which are generally more favorable. These rates vary based on your total taxable income but are capped at 20% for most taxpayers, significantly lower than the top rate for short-term gains.

Special Consideration for Collectibles

Under the recent IRS guidance, certain NFTs may be classified as collectibles depending on their nature and the underlying asset they represent. If an NFT is deemed a collectible and held for more than a year, it's subject to a 28% long-term capital gains rate, higher than the standard rate for other long-term assets.

It's important to understand that the tax rate you'll pay on NFT transactions can be influenced by various factors, including your overall income, the length of time you've held the asset, and the specific nature of the NFT. The distinction between NFTs taxed as standard property versus those considered collectibles under the new IRS guidance can significantly impact the applicable tax rate.

Given the complexities and evolving nature of tax laws surrounding digital assets, NFT investors and creators should consult with a tax professional if they have a complex situation. They can provide guidance tailored to your specific situation, helping ensure compliance and potentially optimizing your tax strategy.

How To Reduce NFT Taxes

Reducing your NFT tax bill can be straightforward with the right strategies. Here's how you can potentially lower your taxes on NFT transactions:

1. Hold for Over a Year: Benefit from lower long-term capital gains rates by keeping your NFTs for more than a year before selling. 2. Time Your Sales: Sell NFTs in years when your income is lower to take advantage of reduced tax rates. 3.Offset Gains with Losses: Use losses from selling NFTs at a lower price than you bought them to offset other gains, reducing your overall tax. 4.Buy with Fiat: Avoid immediate taxes by purchasing NFTs with fiat (such as USD) instead of using appreciated cryptocurrency. 5.Donate to Charity: Donating NFTs directly to qualified charities can bypass capital gains taxes and potentially offer a tax deduction.

While these tips can guide you, consulting with a tax professional is crucial for tailored advice and compliance with the latest tax laws.

How To Calculate NFT Taxes

Navigating NFT taxes can be a challenging endeavor and generally means meticulously reporting gains and losses on capital assets, including NFTs, using IRS Form 8949 and Schedule D. Those deeply involved in creating and minting NFTs must go further, reporting proceeds as self-employment income and potentially facing self-employment taxes. The task can quickly become daunting, with manual calculations requiring extensive time spent scouring block explorers and spreadsheets, a process that's time-consuming and prone to errors.

Recognizing the complexities and the potential for confusion, we developed Crypto Tax Calculator specifically to address the needs of those engaging in on-chain transactions such as DeFi and NFTs. It eliminates the need for manual tracking and complex spreadsheets by seamlessly importing your on-chain DeFi and NFT transactions, as well as your exchange trading activity. Our smart tax engine then takes over, automatically labeling your on-chain activity and elucidating the tax implications of each transaction.

You can then generate CPA-approved tax reports that are comprehensive, accurate, and ready to be filed directly with TurboTax or handed over to your tax preparer. Our aim is to transform what could easily be a taxing nightmare into a manageable and even straightforward part of your trading routine. At Crypto Tax Calculator, we're dedicated to making the complex world of NFT taxes more accessible and less intimidating, allowing you to focus on what you do best: trading and creating in the dynamic NFT marketplace.

Disclaimer The content of this guide is for general informational purposes only. It is not legal or tax advice. Viewing this guide, purchasing or using Crypto Tax Calculator does not create an attorney-client relationship or a tax advisor-client relationship. The information in this guide represents the opinions of experienced crypto tax professionals; however, some of the topics in this guide are still subject to debate amongst professionals, and the IRS could ultimately release guidance that conflicts with the information in this guide. The information contained in this guide is based on the authors’ interpretation of the Internal Revenue Code (“Code”). Changes to the Code may be retroactive and could significantly alter the views expressed herein. Therefore, use this information at your own risk and for information purposes only. Consult a professional regarding your individual tax or legal situation.