Sales of NFTs Create Taxable Income
It is one of the hottest segments of the crypto world: NFTs or non-fungible tokens. It is a market that has ballooned to over $44 billion in sales annually.
What is an NFT? An NFT is a cryptographic asset on a blockchain with a unique identification code and metadata that distinguish it from other assets on the blockchain. Unlike cryptocurrencies, which are identical to each other and therefore can be traded and used as a medium for transactions, each NFT is different from any other NFT. Think of it as a work of art, such as the Mona Lisa painting by da Vinci. The Mona Lisa can be copied but there is only one original painting. NFTs have one original and cannot be copied.
Tech titans such as Mark Zuckerberg say that these tokens are the future of the internet since the tokens are digital certificates of authenticity and cannot be duplicated. Recently a digital artist Mike Winkelmann, known in the digital world as Beeple, sold a token known as “EVERYDAYS: The First 5000 Days” for $69.3 million.
What are the tax implications of these events? The sale of the original token by the creator of that token is ordinary income to the taxpayer, and is subject to income tax, Social Security tax and Medicare tax. Since most of the token creators only accept cryptocurrency as payment, the purchaser also incurs a taxable event, subject to capital gains taxes on the tokens he used to purchase the NFT. The value he pays for the NFT is the deemed sales price of his cryptocurrency, and he is taxed on that amount less his basis in the currency. When the purchaser sells the NFT, any gain is subject to the rules concerning collectible sales, which have a long-term tax rate of 28% versus 20% for most cryptocurrencies, stocks and bonds.
Since the market is highly unregulated, and growing exponentially, the IRS is seeking to clarify the rules regarding the creation, sales, and resale of NFTs, but has yet to release guidance.
Former chief counsel to the IRS, Michael Desmond said that IRS investigators are preparing for a surge in cases this year concerning NFTs. The IRS is anticipating an increase in NFT and cryptocurrency tax evasion due to the expanded activity in these ever-changing markets.
If you have questions concerning NFTs or have any cryptocurrency questions, contact Stanfield + O’Dell.