NFTs and Taxation
Roger Lopez
Chief Marketing Officer & Chief Product Officer, Advisory Board Member , AI, Blockchain, Web3 junkie
While the law surrounding NFTs is rapidly changing, no specific guidelines have been issued by the government on the taxation of NFTs. NFTs are yet to be mentioned in the IRS’s cryptocurrency tax pronouncements. This means that the guide to NFTs taxation is based on general tax principles.
The law recognizes convertible cryptocurrency as equivalent in value to real currency. This means that cryptos can be exchanged or purchased for real currency, and be used in the purchase of goods and services. Cryptos such as Bitcoin and Ethereum are readily convertible to fiat currencies like the US dollar.
For purposes of taxation, the IRS treats convertible cryptos like Bitcoin as property and not currency. Consequently, the general tax principles applicable to property transactions also apply to convertible cryptocurrencies. Even though this approach does not single out non-convertible items like NFTs, many tokens and non-convertible cryptocurrencies will fall under properties for tax purposes.
Buying NFTs Using Cryptocurrencies
Since NFTs are property as opposed to real currency, their transactions are taxed as barter transactions. The seller and buyer of an NFT have a taxable transaction when the payment for an NFT property is made using another property such as a digital token or cryptocurrency. The gain is taxed if the fair market value of the crypto used in the purchase is greater than the tax basis of the taxpayer in that cryptocurrency. At the same time, the seller has a taxable gain/loss, which is the difference between the tax basis of the seller and the value of the property received after payment of the NFT.
Buying NFTs Using Fiat Currency
When an NFT is purchased using Fiat (actual) currency like the US dollar, only the seller will have a taxable sale. The gain or loss incurred is the difference between the adjusted tax basis of the NMFT and the amount of currency used to buy it. In a case where the buyer uses appreciated property to purchase the NFT (the fair value of the property used in the purchase is greater than the tax basis of the buyer), the buyer has a taxable gain equal to the appreciation amount. Consequently, the tax basis of the buyer in that property is relevant for tax purposes.
Treatment of Gains and Losses
Gains or losses incurred in NFT transactions are treated as capital or ordinary. This depends on whether the taxpayer is a trader/investor (capital) or a dealer/creator (ordinary). While capital losses are subject to specific loss limitations of capital assets, ordinary losses are fully deductible. However, when the taxpayer holds an NFT for personal use rather than an investment, any loss incurred can permanently be defined.
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References/Sources
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