The hottest new trend in digital finance is the non-fungible token, or NFT. Countless people are buying their way into it, and in some cases making a significant amount of money!
The NFT itself is not an entirely new concept, but the market developing around them is a brand new phenomenon. The NFT market depends on the system built up around cryptocurrencies, and cryptocurrencies are often used directly for buying and selling NFTs, but the similarities end there.
There are a lot of investment opportunities in the NFT market, and they’re open to anyone who has money to spend. However, before you take the leap and find out what this new digital economy has to offer, you should make sure you understand what you’re getting into.
You also need to be aware of the financial liabilities. NFTs are taxed in various ways, and if you’re not informed before you start investing, you might find yourself overexposed when your tax bill arrives.
What Is an NFT?
An NFT is a digital asset traded online using the blockchain. The blockchain is the same system used to track cryptocurrency transactions, and it tracks NFT trading as well. This means that if you own an NFT, the blockchain essentially verifies that ownership for you and ensures that it can’t be stolen or falsified. Your NFT functions as a certificate of ownership.
NFT stands for non-fungible token, which means that, unlike fungible cryptocurrencies, each NFT is entirely unique. While two bitcoins are identical and fully interchangeable, every NFT is a singular asset with its own value.
Recent NFT trading has centered largely around buying and selling digital art images that don’t exist outside of digital space. However, NFTs can include a wide range of different assets:
- Digital artwork or physical artwork
- Animated GIFs
- Sports highlights and other videos
- Collectible sneakers or other fashion items
- Video game items or rewards
- Other tangible real-life collectibles
Five Key NFT Tax Tips
Understanding what NFTs are and how they work is the first step. However, if you’re going to invest in NFTs or even make money with them, then you need to be specifically aware of how they affect taxes.
Here are five essential tax tips to keep in mind when it comes to buying or selling NFTs.
1. Know the Difference Between Short- and Long-Term Gains
For anyone engaging in investing or trading of NFTs, you’ll need to pay attention to IRS tax rules around capital gains. Your NFTs are capital that you own, like any other stock investment, and you will pay taxes whenever that capital increases in value.
This will require paying careful attention to long-term vs. short-term capital gains, as the capital gains tax rate varies significantly according to the time period. The line for the IRS when it becomes long-term is more than a year. That means if you buy an NFT and sell it exactly a year later, that’s short-term. If you wait 12 months and a day, that’s long-term.
2. NFTs Are Taxable Whether You Sell Them or Don’t
Your NFTs are property and must be reported on your taxes. You should keep track of appreciation or depreciation, although you won’t pay capital gains on the NFT itself until it’s sold.
However, most NFTs are bought with cryptocurrency, which makes that purchase transaction also a taxable event. Spending your cryptocurrency at any point incurs either a capital gain or a capital loss, depending on how the value of the cryptocurrency has changed since you bought it.
Say you buy cryptocurrency and use it several weeks later to buy an NFT. Even if you never sell or trade that NFT, you just made a trade based on an initial investment in cryptocurrency. If the cryptocurrency in question went up in value in those weeks, you will owe taxes based on short-term capital gains. If there was a drop in value, that qualifies as a capital loss, which will count in your favor when calculating liability for income taxes on your personal return.
3. Certain NFT Transactions Are Taxable
You’re also likely to incur a tax liability anytime you sell or trade an NFT. If you are an artist creating and selling NFTs, you’ll have to pay regular income taxes on any money you earn according to your personal income tax bracket.
If you invest in or trade NFTs that you didn’t create yourself, then those transactions will be subject to taxes on capital gains. Whenever you sell or trade away an NFT, you will be responsible for paying taxes according to that asset’s change in value since you purchased it.
This is a tax on the profit you have earned from the exchange. The tax rate for that profit will either be the short-term capital gains rate or the long-term capital gains rate if you purchased it more than a year ago. Short-term capital gains are simply taxed as ordinary income. Long-term capital gains are usually taxed at a lower rate, which will vary according to the individual’s income tax bracket.
The exact tax rates on these transactions will also vary according to how the IRS categorizes these purchases. Some NFTs may fall under IRS rules around “collectibles,” which may mean a higher capital gains rate.
4. Tax Regulations for NFTs Will Continue to Shift in the Coming Years
The rapidly growing digital economy around NFTs is very new, which means legislation and tax procedures around them are still catching up. It is not yet clear how IRS or the U.S. government at large will choose to tax or otherwise regulate these online transactions.
5. An Accountant Can Help You Manage NFT Taxes
If you’re concerned about your potential tax burden, work with an accountant to reduce your exposure with the essential tax checklist for NFT traders. Leave it up to a professional to assess your portfolio and help you avoid any tax liability surprises.
Working with a professional to manage your NFT taxes will also make it easier to keep up with the changing tax policies around cryptocurrencies and NFTs. The situation is changing quickly, so you want to have an expert on your side who can keep track of new developments and ensure you come out on top.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.