Will the IRS Tax NFTs as Collectibles?

 Posted on April 14, 2023 in Taxation Law

In our increasingly digital world, there are numerous different types of assets that people may own, and determining how these assets may be taxed can often be confusing. Non-fungible tokens, or NFTs, are one type of asset that has raised questions in recent years. These digital tokens use blockchain technology similar to cryptocurrency to create unique digital identifiers for certain types of assets. As with some other types of digital assets, the way the IRS taxes NFTs has not yet been fully settled. However, the IRS has recently provided guidance on this issue, indicating that NFTs may be treated similarly to other types of collectibles under the tax laws.

Capital Gains Taxes and NFTs

NFTs use distributed ledger technology (commonly known as the "blockchain") to establish ownership of certain types of assets or to provide certifications of authenticity. A person who owns an NFT will have certain rights with respect to digital assets, which may include images and videos, music, trading cards, items used in video games, or pieces of virtual real estate in online communities. While capital gains taxes may apply when NFTs are sold or transferred to others, the specific tax rates may depend on whether they may be classified as collectibles.

Certain types of assets that are considered collectibles may be subject to higher capital gains tax rates, up to a maximum of 28 percent. The Internal Revenue Code states that collectibles may include works of art, antiques, precious gems or metals, stamps, coins, or other types of tangible personal property. Because NFTs are digital assets, they generally will not be considered tangible property. However, there are some situations where NFTs may be classified as collectibles based on their relationships to pieces of physical property.

When determining whether NFTs are considered to be collectibles, the IRS will use a "look-through analysis" that examines whether an NFT is related to tangible property. If an NFT is used to certify ownership of a collectible such as a coin or gem, it may be considered a collectible for tax purposes. However, if an NFT is used to certify ownership of a digital asset such as a video game item or a location in a virtual environment, it generally will not be considered a collectible.

Some questions still remain about whether NFTs may be considered collectibles in certain situations. For example, when NFTs certify ownership of digital images, videos, or music, it is unclear whether these may be considered "works of art." The IRS is currently reviewing these issues, and it may take steps in the future to decide what factors may determine whether a digital file is a collectible work of art, how to determine whether an asset is considered tangible personal property, how taxation may apply for NFTs that certify ownership of multiple assets that may or may not be collectibles, and how to address situations where NFTs allow for the right to use an asset without providing full ownership of the asset.

Contact Our San Jose, CA Tax Lawyer for Questions About Digital Assets

In our ever-shifting technological landscape, determining how to handle taxes on different types of digital assets can be a complex and confusing process. It is important for owners of NFTs, cryptocurrency, and other digital assets to understand the applicable tax laws in order to avoid potential penalties. At John D. Teter Law Offices, we can provide guidance on these issues and representation during tax audits or other interactions with the IRS. To schedule a consultation and learn more about our services, contact our San Jose tax law attorney at 408-866-1810.

Sources:

https://www.irs.gov/pub/irs-drop/n-23-27.pdf

https://www.law.cornell.edu/uscode/text/26/408