6/27/2023 Update: The IRS has released more information about the taxation of virtual assets related to transactions. Please see here for more.
The IRS and Treasury Department have released a notice signaling their intent to issue formal guidance on the taxation of some nonfungible tokens (NFTs) as collectibles in the coming months. Along with announcing their plans to determine whether certain NFTs may be defined as a section 408(m) collectible and inviting taxpayers to share comments on the subject, Notice 2023-27 provides guidance for the interim.
What Are NFTs?
According to the notice, NFTs are defined as a unique digital identifier that is recorded using distributed ledger technology and may be used to certify authenticity and ownership of an associated right or asset. This may include the right to a digital file, including a digital image, digital music or a digital trading card, or the right to a non-digital file, including a ticket to an event or ownership of a tangible good. It can also include both components.
What is a Collectible and How Might an NFT Be Considered One?
The IRS defines collectibles under Section 408(m)(1) as:
(A) any work of art
(B) any rug or antique
(C) any metal or gem
(D) any stamp or coin
(E) any alcoholic beverage or
(F) any other tangible personal property specified by the Secretary for purposes of this subsection.
In terms of taxation, the IRS is advising taxpayers to treat NFTs depending on the object the NFT represents, known as “look-through analysis”, until further guidance is issued. For example, an NFT may be classified as a collectible if it includes the right to a precious gemstone. However, as many NFTs contain digital files that could be considered a collectible in itself (a digital file could be considered a work of art, even without representing a physical piece of art), the IRS and Treasury Department may decide to subject NFTs to a higher tax rate, depending on what they represent.
What Are the Implications of Taxing NFT Transactions as Collectibles?
Previously, NFT transactions have been subject to general property tax guidance. They are typically taxed as capital gains, with a top tax rate of 20%. However, if more NFTs are considered collectibles, they would be taxed as such, with a top tax rate of 28%. It would also place the burden of determining whether or not a digital file is considered a collectible on the taxpayer.
As there are many gray areas surrounding NFTs (for example, NFTs could contain both collectible and non-collectible components), the determination process could become more complex and nuanced than it currently is.
What Are My Next Steps?
As NFTs offer a new way to purchase, sell and own goods, tangible or otherwise, in a changing economic landscape, there hasn’t previously been much guidance on the subject. As crypto-based transactions become more common, we may expect to see more government regulation in the near future. You may submit your comment on the subject on the Federal eRulemaking Portal through June 19.
As the official guidance to be issued by the IRS may affect your taxes, it’s important to consider your current NFT activities. We will be monitoring the issue and will keep you informed of any updates. If you have questions about NFTs, specifically as it relates to your taxes, please reach out to your Janover representative or contact a team member today.