Next year your NFT could be subject to capital gains tax of up to 28%! | Ingram Yuzek Gainen Carroll & Bertolotti, LLP

Next year your NFT could be subject to capital gains tax of up to 28%!  |  Ingram Yuzek Gainen Carroll & Bertolotti, LLP

Tax day has come and gone, but the work is far from over. On March 21, 2023, the Treasury Department (“Treasury”) and the Internal Revenue Service (“IRS”) issued Notice 2023-27 (“Notice”), which first explains the Treasury Department’s and the IRS’s intent to issue. guidance related to the treatment of NFTs as collectibles under Section 408(m) of the Internal Revenue Code (“Tax Code”), and second, we request feedback on how to effectively implement this guidance.

To understand the first part, the reader must understand what an NFT is and the relevant tax code provisions contemplated in the notice. Fortunately, the notice lays out the basic understanding in a simple yet comprehensive manner that is easily digestible. If you need a further overview, check out our previous article Understanding NFTs and other articles published on our NFT Newsroom.

The most important tax law provisions in the notice are sections 408(m) and 1(h). Essentially, Section 408(m) of the Internal Revenue Code defines an asset to be a “collectible” if it falls into one of six categories: any work of art; any rug or antique; any metal or gem; any stamp or coin; any alcoholic beverage or any other tangible personal property specified by the Secretary for the purposes of this subsection. And Section 1(h) applies the definition of a collectible to capital assets.

These sections are relevant and important to the analysis, because if an NFT is found to be a section 408(m) collectible (and held by the owner for more than one year), then it may be subject to a maximum capital gains tax assessment of 28%. (If the NFT was found not to be a section 408(m) collectible, the NFT would be subject to a lower tax rate.) The note explains that to determine whether an NFT is a section 408(m) collectible, the guidance will analyze whether the assets or rights provided by the NFT falls under one of the section 408(m) collectibles categories.

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In other words, let’s say I own a gem. Pursuant to section 408(m)(2)(C), my pearl is a collectible. Therefore, if I own an NFT that certifies that I own the gem, that NFT is (pursuant to the notice and new guidance) a section 408(m) collectible. Treasury and the IRS have created this analysis as the “look-through analysis.” Let’s try another example. Let’s say I own an NFT that entitles me to join an exclusive club. Under section 408(m)(2), the right to join an exclusive club does not fall within the definition of any of the six categories. Therefore, this NFT will not be a Section 408(m) collectible, and therefore not subject to a maximum 28% capital gains tax rate.

I’m sure you can think of an endless number of examples. That is exactly what the Treasury and the tax authorities are doing by issuing the notice. The second purpose of the notice is to solicit “comments” regarding: other definitions of NFTs that should be used in future guidance; analyze switches to the transparency analysis; how to apply the look-through analysis to NFTs that provide more than one ownership asset or right; other factors to consider when determining whether an NFT is a section 408(m) collectible; what problems the application of section 408(m) may raise, and other guidance that may be useful. For the complete list of questions, check out the notification.

There are mixed thoughts about the impact of the announcement. On one hand, the announcement could provide clarity regarding the tax obligations of NFT collectors, as stated by Miles Fuller, head of government at crypto tax firm Tax Bit and former IRS advisor. On the other hand, the announcement could create more confusion and turmoil about the tax obligations of NFT collectors if it does not address whether the guidance will apply to future NFT sales or apply retroactively, as Andrew Gordon, an Illinois-based tax attorney opined. specializes in cryptocurrency and NFTs.

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If you have any thoughts on the matter, the Treasury and Inland Revenue are accepting written comments until 19 June 2023. You can submit your comments either:

  1. Electronically through the Federal eRulemaking Portal at www.regulations.gov (enter “Notice 2023-27” in the search field on the Regulations.gov home page to find this notice and submit comments); or

  2. By mail to: Internal Revenue Service, Attn: CC:PA:LPD:PR (Notice 2023-27), Room 5203, PO Box 7604, Ben Franklin Station, Washington, DC 20044 Be sure to include a reference to Notice 2023- 27 . All comments submitted using one of the two methods will be made available on the Treasury’s and the tax authorities’ public document.

Alternatively, or in addition, we would like to hear your thoughts on the matter. Are the Treasury and tax authorities creating an illusion of transparency and cooperation by asking for comments from the public? Are they asking the public to do much of the “heavy lifting” in the formulation of this guideline and the scope of its application? Will the guideline be a guideline or will it be incorporated into the tax law? Would you be interested in reading a summary or overview of the comments submitted?

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