2021 will be remembered as the year of non-fungible tokens (NFTs). In a year in which names like Beeple and Bored Ape Yacht Club dominated the headlines, NFT trading is estimated to have topped $23 billion.
The advent of NFT has spawned a new generation of investors who are spending time searching platforms like Discord and OpenSea for a 100x next chance. However, it is important for today’s NFT investor to keep the tax implications in mind. Otherwise, they risk repeating the mistakes of the past.
After the bullish run of 2017, many cryptocurrency traders found themselves in a bind. Although they made significant tax commitments during the market boom, they no longer had the money to pay their tax bills after the crash. Many of these traders were simply unaware of the tax implications of their trading and did not prepare accordingly.
In this article, we’ll cover three things all NFT investors should know about taxes if they want to make a profit without getting into trouble with the Internal Revenue Service or the IRS.
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You will likely be charged taxes when purchasing NFTs.
Getting rid of your cryptocurrency is a taxable event and buying an NFT with Ether (ETH) or other cryptocurrencies falls into this category. You will incur a capital gain or loss depending on how the price of your cryptocurrency has changed since you originally received it.
Many NFT traders bear a heavy tax liability because the price of their coins has skyrocketed since they were originally received. To avoid tax problems, you should calculate your potential tax bill for each transaction you make and try to save money before tax season.
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Taxed when you sell your NFT
The sale of your NFT is also a taxable event, whether you sell it for fiat or cryptocurrency or exchange it for another NFT. NFTs are taxed in the same way as cryptocurrencies – taxable income from the sale of an NFT is determined by calculating the difference between the original purchase price of the NFT and the total proceeds you receive from the sale.
If your NFT has decreased in value since you originally received it, you may be able to claim a capital loss and reduce your tax liability if you hold the NFT as an investment and not for personal use.
You can tell if an NFT is for investment or personal use by looking at your reason for making the purchase. Do you intend to make money, or do you just intend to enjoy the NFT for your own use, without thinking about whether the asset’s value will go up?
A capital loss from an investment can offset annual capital gains and up to $3,000 in ordinary income. Capital losses from personal use are not deductible.
Your NFTs can be considered collectibles
One of the reasons why NFTs are so difficult to classify for tax purposes is that they are a new type of asset class. Unfortunately, this means that tax authorities have not yet issued clear tax guidance on whether certain NFTs will be considered collectibles and will be taxed at a higher rate.
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Certain tangible assets are considered holdings under tax laws. This includes art and metals such as gold, stamp sets or baseball cards. When these assets are sold after a year, they are taxed at a maximum rate of 28% compared to the typical long-term capital gains rate, which ranges from 0 to 20%.
It is reasonable to conclude that certain NFT artworks will be treated as collectibles for tax purposes. It likely includes 1/1 artwork created by Fidenza.
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What about profile picture groups like the Bored Ape Yacht Club group? It’s easy to see why the IRS considers them to be collectibles since 10,000 unique photos are part of the “collection.” However, the problem has not yet been completely resolved.
Any NFT that is not a work of art will likely not be subject to the tax rules for collectibles without further guidance from the IRS. For example, it is reasonable to assume that NFTs representing Uniswap v3 liquidity positions will not be considered holdings.