The tax authorities are seeking public comment on whether they should tax NFTs as works of art
Yesterday, the IRS announced that it is requesting comments on how to treat non-fungible tokens (NFTs) for tax purposes. More specifically, it considers whether to treat NFTs as “collectibles.”
For tax purposes, a collectible is treated the same as a capital asset, except that when it is sold after more than one year of ownership, any realized gain has a maximum long-term capital gains tax rate of 28%. This does not apply to persons who had their NFTs for less than a year and who would be taxed at ordinary tax rates. Also full-time NFT dealers will not only be taxed at ordinary income rates, but may also be subject to self-employment tax.
In its announcement, the IRS defines an NFT as a unique digital identifier that is recorded using distributed ledger technology and can be used to certify the authenticity and ownership of an associated right or asset. Owning an NFT can give the holder rights, privileges and ownership of other assets.
Under the tax code, a “collectible” is one of the following:
- A work of art
- A rug or antique
- A metal or a gem
- A stamp or coin
- An alcoholic drink
- Any other tangible property specified by the Financial Secretary.
Until further guidance is issued, the IRS intends to determine whether an NFT is a collectible using a “look-through” analysis. This means that the tax authorities will consider an NFT to be a collectible if the associated right or asset is also a collectible. For example, an NFT will be treated as a collectible for tax purposes if the owner has ownership of one of the items listed above.
The tax authorities request comments on the following:
- Whether there are more precise definitions of NFTs.
- Pros and cons of using their “see through analysis” to determine if an NFT is a collectible.
- Whether there are other factors to consider when deciding whether an NFT is a collector’s item. How, for example, can an NFT be considered a work of art? Or whether an NFT is tangible personal property in the context of digital files.
- What other guidance related to NFTs would be helpful.
It is unclear why the tax authorities are making this announcement. From an investment perspective, most NFT owners obviously don’t want “collectibles” treatment for tax purposes, as that would increase their tax bill if they sold it at a profit. But others may welcome this development as it could lend legitimacy to NFTs and differentiate them from cryptocurrencies.
But are NFTs similar to other collectibles such as artwork, antiques, gems, coins, or the 100-year-old brandy from a totalitarian dictator’s private collection? Collectibles tend to be rare or unique, considered highly valuable and expensive, have a history, and have some form of aesthetic or functional value. Since they tend to be adult toys for the wealthy, Congress believed that a higher tax rate on their sale would be justified. It is too early to say whether NFTs will reach that status or disappear like last year’s fad or become a get-rich-quick scheme.
It seems that tax authorities will become more involved in the digital asset scene. To their credit, they are seeking public comment on how to treat NFTs, which will hopefully attract a wide range of perspectives. Comments will be accepted until June 19.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolving tax disputes. He is also sympathetic to people with large student loans. He can be reached by email at [email protected]. Or you can connect with him on Twitter (@stevenchung) and connect to him further LinkedIn.
