What are the Tax Implications of Buying and Selling NFTs?

Non-fungible tokens (NFTs) have taken the Internet by storm. While NFTs are not new, they have exploded in popularity over the past year, and companies and investors of all sizes are currently seeking to cash in. Like all assets, NFTs have tax implications, and failing to report and pay tax on NFT transactions can have serious consequences. In this article, Boston tax lawyer Kevin E. Thorn, Managing Partner of Thorn Law Group, provides an introduction to what creators, buyers and sellers need to know.

NFT Transactions Have Federal Income Tax Obligations

While the Internal Revenue Service (IRS) has yet to provide specific guidance regarding the tax treatment of NFTs, it is generally understood that NFT transactions are taxable. The IRS categorizes cryptocurrency as property for income tax purposes (as opposed to classifying it as a currency), and it appears highly likely that when (and if) the IRS provides specific guidance regarding NFTs, it will place NFTs in this same category. As noted in a recent article published by the Journal of Accountancy, “Even more than ‘cryptocurrency,’ . . . NFTs bear some traditional hallmarks of property.”

What does this mean for creators, buyers and sellers? Fundamentally, it means that NFT transactions are reportable events. Creators must calculate the profit they generate from selling their NFTs, and investors must calculate their gains (or losses) upon resale. Furthermore, if a taxpayer purchases an NFT with cryptocurrency or exchanges one NFT for another, this will also trigger a gain (or loss) that is subject to reporting.

Do NFT Transactions Trigger Ordinary or Capital Gains (or Losses)?

Whether NFT transactions trigger ordinary or capital gains (or losses) depends on the circumstances of each individual transaction. Broadly speaking, the rules that apply to other types of assets (i.e. inventory and securities) also likely apply to NFTs.

For creators, NFTs may qualify as inventory. This means that they would not qualify as capital assets. An NFT will also be classified as an ordinary asset if it represents, “a patent, invention, model, design (whether or not patented), a secret formula or process, a copyright, a literary, musical or artistic composition, a letter or memorandum, or similar property.”

For investors, it is more likely that their NFT holdings will qualify as capital assets. This means that selling an NFT within one year of purchase would trigger short-term capital gains tax, while investors who hold their NFTs for a year or longer would be able to pay the reduced long-term capital gains tax rate upon disposition. Notably, the intangible nature of NFTs also means that investors should be able to amortize their adjusted basis under Section 197 of the Internal Revenue Code.

Request a Consultation with Boston Tax Lawyer Kevin E. Thorn, Managing Partner of Thorn Law Group

If you need to know more about the tax implications of NFTs, we encourage you to schedule a confidential consultation at Thorn Law Group. To request an appointment with Boston tax lawyer and Managing Partner Kevin E. Thorn, please call 617-692-2989, email ket@thornlawgroup.com or tell us how we can reach you online today.