We all have to do our taxes. No one likes to pay them, but it’s a necessary evil. Unless you’re lucky enough to live in a country with no income tax. But even there, you probably have some other kind of tax—sales tax, value-added tax, property tax, etc. Even NFTs and crypto are subject to taxation!
Taxes and NFTs might seem like water and oil, yet most people aren’t aware of how their local tributary policies interact with them. Better learn how they work before you buy NFTs!
Let’s find out in what ways NFTs are taxed:
How do taxes affect NFTs?
NFT artists, creators, and traders that derive income from the creation and sale of NFTs are subject to both ordinary income tax and self-employment tax.
That’s because certain NFTs are considered collectibles, and investors who make a profit from holding them for more than one year to capital gain rates of 28%.
Clark Number highly advises artists, investors, and gamers who trade NFTs to carefully document the details of their transactions, including associated fees.
Which NFT actions are taxable events?
Creating the NFT is not a taxable event, meaning you can mint as many NFTs as you want without paying taxes.
However, IRS guidelines state that crypto-to-crypto transactions are taxable events.
Purchasing the NFT using crypto is a taxable event, as is trading the NFT for another. Selling the NFT for crypto is also taxable.
Let’s illustrate this with an example:
If you purchase an NFT with ETH, you’re disposing of the crypto as if it were disposable income, even if it’s not fiat currency.
If you purchase an NFT using crypto like Ethereum, you could trigger a taxable event as the IRS could see it as you are selling your ETH for fiat and using it to purchase the NFT. You’ll be taxed on the price of the initial ETH purchase.
A pump and dump NFT scam uses underhanded speculative tactics to raise an asset’s price artificially. When a person or a group purchases many digital assets to increase their value and liquidity, scammers dump their assets for a profit.
This means you’re liable for capital gains taxes if the crypto increases in value. Gas fees are added to the transaction cost, though it’s unclear how they’ll be taxed as of now.
On the other hand, when you sell an NFT, you’ll owe capital gains tax on value increases of that NFT.
Crypto tax rates are variable depending on when you purchased the NFT, and its value increases.
How do taxes affect NFT airdrops?
In case you’re airdropped an NFT, things get a little unclear. Airdrops are technically taxed as ordinary income when the assets enter your wallet. If you don’t claim the airdropped NFT, you won’t be taxed as you’re not holding the asset. However, selling the airdrop is a taxable event, and you’ll be subject to capital gains tax rates.
You have to be extra careful with rug pull scams, as there’s no buyer or seller protection for worthless NFTs after a pump and dump.
You can learn more about pump and dump scams on our guide here and about software to prevent it from happening here.
There aren’t any clear tax guidelines on how NFT royalties are taxed. Secondary sales will most likely be treated as self-employment tax.
NFTs possibly fall into a category of assets labeled collectibles by the Internal Revenue Code. Collectibles are assets held for more than a year that are a work of art, antiques, metals or gems, a stamp or coins, alcoholic beverages, or tangible personal properties.
NFTs could fall into the category of works of art, but the advancement of the NFT industry through Blockchain technology has increased the definition of NFTs.
Non-fungible tokens are being used in the food industry, the fashion industry, real estate industry, entertainment industry, music, and even law. How can one consider a legal document minted as an NFT?
Donating NFTs to charities, causes, movements, organizations, or even individuals isn’t a taxable event. As long as the NFT donor meets specific criteria, they can be used to offset gross income:
- If the NFT was held over a year.
- It’s donated directly to the organization.
- It’s donated to a 501 (c) (3) organization.
What are the capital gains tax rates for NFTs?
Depending on the time spent holding the NFT before selling it, it might be held to different capital gains tax rates.
To avoid higher tax rates on crypto, prioritize making long-term crypto trades when possible. Short-term sales of NFTs are taxed at 38%.
Some think that because NFTs are also used as investment vehicles, their asset class would be treated as a regular capital asset and taxed through the standard crypto capital gains tax rate.
On top of that, NFTs are intangible digital files, and the tax code only classifies tangible objects as collectible items.
If the NFT is sold or disposed of within a year of buying, it’s subject to only short-term capital gains.
The IRS hasn’t published clear guidelines on the income tax treatment of NFTs, but they could be scrutinized if you’re subject to audit.
You can check out the IRS’ cryptocurrency tax FAQs for more information before you learn how you buy NFT.
Final words about taxes and NFTs
There are different guidelines and sometimes conflicting information on how taxes affect NFTs. None of the information stated in this article should be taken literally and only as pointers in the right direction.
Remember to consult guidelines for NFTs and taxation in your home country to always be on the same page as your local tributary department.
Check out our other guides on What are NFTs to learn more about how to get an NFT, how to make NFT, and how artists can benefit from them here.
