Non-fungible token (NFT) is a unique digital asset that can be sold or traded. An NFT is recorded, stored, and transferred on a blockchain, which is a kind of digital ledger, and can be purchased or sold using cryptocurrency or legal tender currency such as the U.S. dollar.
In NFT, the term ‘non-fungible’ means that it is unique and does not have an identical replica. For example, physical money such as a $10 bill can be exchanged for another $10 bill because there are millions of replicas of it, but an NFT is a one-of-a-kind digital asset that cannot be duplicated. You cannot trade one NFT for exactly the same NFT.
NFT creators such as artists, musicians, influencers, sports fans, celebrities, etc. can sell or trade their creations in the NFT marketplace. It has opened up an entirely new market platform for them. As for taxes, NFT creators need to be aware of how the IRS will treat their income from NFT and how it will be taxed.
Tax Obligations of NFT Creators
Due to the newness of NFTs, the IRS has not yet provided guidelines on how NFT creators will be taxed. Yet, taking cues from the IRS tax rules for virtual currency, NFT creations will be taxed by the IRS just like any other property. Since an NFT creation can be sold or traded, the income received from the sale will be taxed as income. However, simply creating an NFT art and putting it out for sale or showcasing it will be tax-neutral since no income is generated from it.
Since virtual currency has an equivalent value in real currency, it is a substitute forof real currency, and is, therefore, taxed similarly. For example, bitcoin can be traded for another bitcoin, U.S. dollar, or other virtual currencies. That makes it taxable just like real currency. According to the IRS, “Virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency.”?
Taxes on Selling NFT Art
Taxpayers selling an NFT art need to report any capital gain or loss from the sale in their tax return. If you held the virtual currency from the sale of an NFT art for one year or less, it needs to be treated as a short-term capital gain/loss. However, if you held it for over a year, it will be treated as long-term capital gain by the IRS.
Any gain or loss from the sale of an NFT needs to be reported on a federal tax return in U.S. dollars. When converting a cryptocurrency into U.S. dollars, make sure that the fair market value of the cryptocurrency is calculated at the date and time the transaction happened, and not when the return is being prepared.
Since NFTs are different from other cryptocurrencies such as bitcoin in the sense that NFTs are unique or “non-fungible”, their dollar value can be difficult to ascertain. Normally, the value of an NFT is set by the seller and/or the buyer. This poses the problem on how to convert its value into U.S. dollars. Due to the non-availability of specific tax instructions by the IRS on NFTs, many taxpayers find it difficult to correctly pay taxes on NFT income, use deductions on NFT donations, and so on.
Independent contractors such as artists, influencers, etc. who are self-employed need to treat income from NFT trading as self-employment income. To know more onabout how your income from NFT trading will be treated by the IRS, visit IRS FAQs on Virtual Currency Transactions.
Even if an NFT art is exchanged for another NFT art, it is considered bartering by the IRS and is, therefore, taxable. When bartering NFT art, you need to take the fair market value of the property (NFT) received by you, and include it in your income.
Digital assets such as NFTs are presenting a new challenge before the IRS. The agency needs to establish and announce tax rules for NFTs at the earliest so that taxpayers can accurately calculate and pay their taxes.