NFT tax guide – tips for non-fungible token creators and investors

    In 2021, high-profile sales of digital art and other digital collectibles such as CryptoPunks sparked interest in non-fungible tokens, or NFTs, which led to the surge in the NFT tax. According to research platform Dapp Radar, $25.5 billion in NFTs were sold last year, making it the most popular year ever for what many regards as a new frontier in digital investments.

    Some traders are profiting from all of the speculations, and NFT designers are also profiting from their virtual creations. However, in this rapidly evolving sector, the IRS has yet to provide clear guidance on several tax concerns, adding to the ambiguity.

    So, what should investors and creators know and how should they respond when filing taxes?

    Investors and creators don’t owe tax until an NFT sells

    If you’re making or trading NFTs, you won’t have to pay tax until the NFT sells. It’s the same for a creator as it is for someone who creates something, like a painting. They realize revenue from the production when they sell the painting, but not before. That money will be treated as ordinary income and taxed in the same way as any other wage.

    If a trader sells an NFT for a profit, they will owe taxes. However, they can keep their unrealized gains as long as they have the NFT and do not sell it. According to Christopher Rogers, senior tax partner at Capital Fund Law Group in New York City, the IRS has left it unclear how traders should account for those gains.

    “There are two schools of thinking among tax specialists,” he continues. “The first is that NFTs should be handled in the same way as capital gains. However, the majority of opinion is that they should be classified as collectibles and subject to a different tax scheme.”

    You’ll owe capital gains taxes on net profits if you regard NFTs as capital gains. The silver lining is that if you lose money on a trade, you can offset it with profits. In fact, you can deduct up to $3,000 in net capital losses from your taxable income per year. According to Rogers, this tax treatment is often more favorable for people, depending on their income, than treatment as a collectible, which can result in rates as high as 28 percent.

    Even NFT buyers may be creating tax liabilities

    If you buy NFTs with cryptocurrency like Ethereum, you’re potentially generating a separate liability from the NFT itself. Because of how the IRS has framed the laws around using crypto, any transaction with it has the potential to generate a tax issue.

    If you exchange virtual currency for products or services that are worth more than your cryptocurrency’s cost basis, you will incur a tax burden. For example, if you bought $1,000 worth of Ethereum and then spent it on $3,000 worth of NFTs, you’ve established a tax obligation and will owe tax on that transaction. (You could also lose money.) The IRS guidelines make it difficult to utilize bitcoin as genuine cash, and they apply to all crypto transactions, including the purchase of NFTs.

    You owe tax on NFT royalties and income, too

    Some NFTs have “smart contracts” that pay a fee to the original author every time the NFT is sold. For example, the investor may sell to Person A, who then sells the NFT to Person B six months later. The creator may receive a royalty of a few percent on that second-hand sale by Person A, depending on the NFT, resulting in tax liability for the creator.

    Of course, depending on the cost basis and sale price of the NFT (see point 1 above), as well as the value received for the cryptocurrency, that second-hand transaction might result in a taxable gain or loss for Person A.

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