As the NFT market boomed in 2021, so do the questions around taxation come the next tax season.
The Internal Revenue Service wants its share of the NFT loot. There is a lack of clarity on how NFT holders should be taxed, but tax experts say taxes could be as high as 37%. You can’t fail to report gains or losses because the IRS hasn’t provided advice that meets your expectations, says San Francisco tax attorney James Creech.
NFTs, or non-fungible tokens, are certificates on a blockchain representing ownership of a digital asset. They cannot be replicated. They increase in price based on their rarity or real-world utility. Chainalysis reports that the NFT industry saw $44B in transactions in 2021. Some were huge gainers, with an American artist selling an NFT for over $69M besides royalties. This raises some questions on how they should be taxed. Currently, the guidance on the taxation of NFTs is not entirely clear, but that does not mean that they should not be reported on your tax return.
In fact, those who haven’t reported quarterly income from NFTs may be in for a nasty surprise when penalties hit them next tax season. Owners of NFTs can sell them on NFT marketplaces, such as Opensea or Rarible, and may be subject to income tax of up to 37% when the NFT is sold. NFT buyers owe IRS capital gains tax if they use another cryptocurrency to purchase the NFT.
Tax experts weigh in
Arthur Teller, chief operating officer of TokenTax, estimates a billion-dollar value range for NFT taxes. Beyond the 37% income tax, the tax obligations remain somewhat opaque. Should they be taxed up to 28%, the rate charged for capital gains from art collectibles? The Treasury department offers no specific guidelines on how NFTs will be treated, in light of Joe Biden’s new tax infrastructure bill. As a result, tax evasion may become a distinct possibility, according to Jarod Koopman, a director of criminal investigation at the IRS.
General IRS Crypto Tax Guidelines
The IRS provides an overview of the taxation of cryptocurrencies in Notices 2014-21, 2014-16IRB938, Rev. Rul 2019-24, 2019-44 IRB1004 and ILM 20214020. It must be said that none of these contain any reference to NFT. Section 61 of the Internal Revenue Code (IRC) could require the inclusion of the creator’s income on the proceeds of NFT sales and royalties, Section 197 could provide depreciation for the buyer using the NFT for commercial. Foreign buyers will be subject to taxes in their jurisdiction. At the same time, copyright owners, if they are US citizens, may have to pay state and federal taxes on the royalties they collect.
