How are NFTs Taxed?
The IRS has issued guidance towards the treatment of virtual currencies with the intent to target cryptocurrency users and enforce compliance. However, even though NFTs aren’t considered to be virtual currency, they can still be subject to tax liability.
Determining tax liability for NFTs is a two-step process. First, the taxpayer must determine the method by which they profited from their NFT. If the NFT was sold by its creator, the proceeds (sale price minus production and associated costs) are considered income.
If it was sold by an owner, the sale is considered a “transfer of license” and is subject to property tax. A “transfer of license” is a right to use the property in any manner that an owner chooses.
If the disposition of the NFT is subject to property tax, the taxpayer must calculate the length of time for which they possessed the NFT to determine whether they are subject to short-term or long-term capital gains tax. See Internal Revenue Code 1221(a)(3).
Determining Your Earnings Method
If the taxpayer is a creator who earned money (either fiat or convertible) from selling an NFT, their earnings will be considered “income” and taxed as income according to the earning bracket in which their income lies (10% to 37%).
Income earned from selling NFTs is also subject to the self-employment tax (15.3%).
However, by and large, most users who earn profits from NFTs do so by trading or selling NFTs that they own but did not create.
In these instances, much like fungible cryptocurrency, their gains will be subject to the capital gains tax.
Just as simply owning fungible cryptocurrency isn’t a “taxable event”, simply owning an NFT also isn’t considered a taxable event. Common taxable NFT situations include:
- Selling an NFT for cryptocurrency. A sale will usually generate a profit and will thus hold the seller liable for capital gains tax.
- Purchasing an NFT with cryptocurrency. When you purchase an NFT using a cryptocurrency, this constitutes a disposal of the cryptocurrency and will incur a capital gain or loss. Note that is not the same as purchasing an NFT with fiat currency (dollars or euros).
- Trading one NFT for another, if the trade value is greater than or less than what you purchased it for.
For example, if you purchased an NFT for $500, but then traded it for an NFT valued at $700, you would have a capital gain of $200 and would be required to pay taxes on the $200 profit.
Conversely, if you purchased an NFT for $500 but traded it for an NFT worth $300, you sustained a $200 loss. This loss may be used to offset taxes incurred from other cryptocurrency or NFT transactions.
Trading NFTs of equal value does not constitute a taxable event.
Earning royalties or commissions from the sale or use of an NFT.
The following scenarios do NOT constitute taxable events and are NOT required to be reported as capital gains or losses:
Purchasing an NFT with fiat currency. As you may remember, simply owning an NFT does not impose tax liability.
Purchasing an NFT with fiat currency (which is most likely income that you’ve already paid taxes on) does not require you to pay a capital gains tax.
Selling an NFT for payment in fiat currency. If you’re a creator and you’re selling your creations for fiat currency in lieu of payment in cryptocurrency, you’re not required to pay capital gains tax.
You will however, need to report your income as self-employment and pay the appropriate self-employment tax.
Trading NFTs of equal value does not constitute a taxable event. The trade of an NFT of equal value does not equate to a capital gain or loss and thus does not need to be reported.
Is the Sale Subject to Short-Term or Long-Term Capital Gains Tax?
Much like fungible cryptocurrency, NFT capital gains tax rates will be determined by calculating how long the NFT was held for. If the holding period was less than one year, the sale will be subject to short-term capital gains tax rates. If the NFT was held for longer than one year, it will be subject to long-term capital gains tax rates.