As non-fungible tokens (NFTs) have gained mainstream popularity, it’s essential to understand the tax implications associated with these crypto assets. In this guide, we’ll explore how NFTs are taxed in the United States in 2023 and offer general tips for minimizing your NFT tax liabilities.
Table of contents
- Introduction to NFTs
- How are NFTs taxed
- Taxes when buying NFTs
- Can NFTs be taxed as collectibles?
- NFT taxes for creators
- Tax loss harvesting with NFTs
- Giving or receiving NFTs as gifts
- Donating NFTs to charity
- Reporting NFTs on your tax return
- Strategies for minimizing NFT taxes
Introduction to NFTs
NFTs are unique digital assets that are stored and authenticated on a blockchain, such as Ethereum. NFTs have become an increasingly popular means of producing and distributing unique digital art, music, and more, and every NFT contains metadata to validate creation, ownership, and transaction history. Some NFT projects you might be familiar with include CryptoPunks, Azuki, or Bored Ape Yacht Club.
How are NFTs taxed?
There are many taxable events that can be triggered by buying, selling, gifting, or otherwise acquiring or transferring NFTs. For the most part, in the United States, NFTs are classified as property by the Internal Revenue Service (IRS), meaning that they are subject to short-term and long-term capital gains taxes, just like company stock or cryptocurrency. But it’s not always black and white, and the tax code for NFTs in the United States is rapidly evolving.
Taxes when buying NFTs
If you use a cryptocurrency such as Bitcoin or Ethereum to buy an NFT, you will be subject to capital gains taxes on the crypto used in the transaction, and subsequently, on the NFT itself should you eventually sell it. This is because the IRS treats crypto as property, and exchanging one property (crypto) for another property (NFT) is considered a taxable event. Purchasing an NFT with fiat currency (like US Dollars), however, does not typically trigger a taxable event.
Capital gains taxes when selling NFTs
When you sell an NFT, you will owe capital gains taxes, which will be calculated based on how long you held your NFT before selling:
- Short-term capital gains: If you sell an NFT after less than one year of holding it, you will pay short-term capital gains tax, which can be as high as 37% depending on your total annual taxable income.
- Long-term capital gains: If you sell an NFT after more than one year of holding it, you will owe long-term capital gains, which can be anywhere from 0% to 20% for 2023.
Can NFTs be taxed as collectibles?
It depends. In a memo published on March 21, 2023, the IRS stated that specific NFTs might be considered collectibles on a case-by-case basis via a “look-through analysis”. The memo states that “for example, a gem is a collectible under section 408(m); therefore, an NFT that certifies ownership of a gem is a collectible”. Collectibles are not taxed in the same way as traditional assets, and are subjected to a maximum capital gains tax rate of 28%.
NFT taxes for creators
Creators of NFTs will need to pay taxes on any income generated from the sale of their NFTs. The taxes owed may also vary depending on whether you sell NFTs as an individual or as a business.
The process of creating an NFT, known as minting, does not trigger a taxable event. However, when you sell an NFT that you minted, you will need to report the income from the sale.
Selling NFTs you’ve created
When you sell an NFT you’ve created as an individual, the income generated is considered ordinary income. This means that the proceeds from the sale of your NFTs will be taxed at your individual income tax rate, which can range from 10% to 37% depending on your total annual taxable income.
Royalties from NFTs
If you receive royalties from the resale of your NFTs, this income is also considered ordinary income and should be reported on your income tax return.
Tax loss harvesting with NFTs
When you sell an NFT for a price lower than what you paid, you experience what is called a capital loss. Capital losses can be used to offset capital gains from other investments through a strategy called tax loss harvesting, which can help you reduce your overall tax liability.
After selling an NFT at a loss, you may want to invest in a similar NFT or another asset class. However, keep in mind the wash sale rule, which prevents you from claiming a loss on a crypto asset if you buy the same or substantially identical asset within 30 days before or after the sale.
Giving or receiving NFTs as gifts
If you receive an NFT as a gift, taxes will only be applicable if you choose to eventually sell it. For those considering gifting an NFT to someone else, keep in mind that the US tax code allows for an annual gift tax exclusion of $17,000 per recipient in 2023. Additionally, there is a lifetime exclusion amount of $12.92 million as of 2023. If the total value of your gifts to an individual, including NFTs, exceeds $17,000 during the calendar year, you will be required to report the additional amount on your tax return.
Donating NFTs to charity
If you choose to donate an NFT to a qualified charitable organization, you may be eligible for a tax deduction. The amount of the deduction will generally be equal to the fair market value of the NFT at the time of the donation. Making a charitable contribution to a 501(c)(3) or other non-profit organization can be an effective way to both offset your capital gains and support an organization you believe in.
Reporting NFTs on your tax return
To report NFT transactions on your tax return to the IRS, you’ll need to work with your accountant or Harness Tax Advisor on completing a number of different forms, some of which we’ve listed below:
- Form 8949: Use this form to report your NFT transactions. You’ll need to provide details on each transaction, including the date acquired, date sold, cost basis, and sale proceeds.
- Schedule D: This form will summarize your total capital gains and losses and will be submitted along with your Form 8949.
If you earned income from NFTs, such as royalties or sales of self-created NFTs, you may also need to report this income on the following forms:
- Schedule 1: This form will report additional income, such as royalties, as part of your Form 1040.
- Schedule C: If you’re considered self-employed and earn business income from creating and selling NFTs, you’ll need to report this income and any related expenses on Schedule C.
Strategies for minimizing NFT taxes
To summarize, there are many ways to minimize your tax liability on NFTs. Here are just a few to consider:
- Hold NFTs for more than a year: By holding NFTs for more than a year before selling, you can benefit from lower long-term capital gains tax rates.
- Consider tax loss harvesting: As mentioned earlier, strategically selling NFTs at a loss can help offset capital gains on other investments, potentially reducing your overall tax liability.
- Donate NFTs to charity: Donating NFTs to a qualified charitable organization can provide you with a tax deduction while also supporting a cause you care about.
- Invest in NFTs through retirement accounts: If permitted by your retirement account provider, investing in NFTs through a self-directed IRA or other tax-advantaged retirement accounts can defer taxes on gains until you withdraw the funds during retirement.
- Buy NFTs with fiat currency: Using fiat currency, like US Dollars, to buy NFTs can simplify the tax implications of your transactions and reduce your capital gains taxes. Purchasing an NFT with US Dollars instead of a cryptocurrency like Bitcoin can prevent an additional taxable event.
Work with a Harness Tax Advisor
Navigating the tax landscape for NFTs can be complex, and it’s important to work with a financial advisor or tax professional who truly understands this rapidly-evolving asset class. At Harness Wealth, our advisors are well-versed in NFTs and crypto assets, and are available to help with every step of your crypto investment journey. If you need tax planning or financial advice for your NFTs, sign up for Harness Wealth today.