The IRS offers tax guidance on NFTs
The Internal Revenue Service and the Treasury Department issued preliminary guidance on Tuesday and intend to issue more detailed guidance soon on the tax treatment of non-fungible tokens, digital collectibles that became popular investment vehicles before the cryptocurrency market plunged last year.
IRS and Treasury released Message 2023-27 is asking for feedback on various aspects of the future guidance, but also said Tuesday that until the supplemental guidance is issued, the IRS intends to determine when an NFT is treated as a collectible using a “look-through analysis.” During the look-through analysis, an NFT is treated as a collectible if the NFT’s associated right or asset falls under the definition of collectible in the Tax Act. For example, a gemstone is considered a collectible under section 408(m) of the Internal Revenue Code, so that means an NFT confirming ownership of a gemstone is also a collectible.
An NFT is a unique digital identifier that is recorded through distributed ledger technology, such as the blockchain technology underlying cryptocurrencies such as Bitcoin and Ether, and can be used to certify the authenticity and ownership of an associated right or asset. Distributed ledger technology uses independent digital systems to record, share and synchronize transactions, the details of which are recorded simultaneously on multiple nodes in a network. A token is a record of data encoded on a distributed ledger. A distributed ledger can be used to identify ownership of both NFTs and fungible tokens, such as cryptocurrency, as described in Fox. Roll. 2019-24.
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Section 408(m)(2) of the Internal Revenue Code includes a specific list of items that constitute collectibles for certain purposes. Acquisition of a collectible from an individual retirement account or individually directed account for a qualified plan is treated as a distribution from the account equal to the cost to the account of the collectible. Generally, collectibles also do not have the same favorable tax treatment as other capital assets.
The guidance issued Tuesday also solicits comments on the treatment of NFTs as collectibles and describes how the IRS intends to determine whether an NFT is a collectible until further guidance is issued. IN Message 2023-27, the Treasury Department and the IRS request comments on all aspects of NFTs that may affect the treatment of an NFT as a collectible, as well as certain comments specifically identified in the notice. The tax treatment is also relevant for other purposes in the Tax Act, including the long-term capital gains tax rate under § 1(h). The notice also describes how the IRS intends to determine whether an NFT constitutes a section 408(m) collectible, pending issuance of this guidance, and solicits comments generally on the treatment of NFTs as a section 408(m) collectible, as well as comments to specific questions listed in the announcement.
The IRS notice comes at a time when the NFT market has seen a bit of a resurgence after a sharp decline last year. DappRadar reported that NFT trading volumes increased to $2 billion in February, the highest amount since the crash of several prominent crypto tokens in May 2022. However, following the failure of Silicon Valley Bank and Signature Bank just over a week ago, NFT trading volumes has plunged once again, according to CoinDeskwith the lowest number of active NFT traders since November 2021.
