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Mar 16, 2023
As with any new industry, there isn’t a simple answer to that question. There are a few factors necessary to determine before you will know with certainty what tax rate you will pay for a NFT transaction.
In this article, we’ll break down everything you need to know about what you owe on your NFTs for a variety of common situations including buying, selling, and receiving NFTs in 2021. We will also include information that can help you reduce this tax burden for years to come.
The first and most important question to answer is do I have to report NFTs on my tax return?
The answer to this is probably, even if you didn’t sell any NFTs.
The IRS released information in 2022 stating that NFTs would be considered ‘digital assets’, similar to any cryptocurrencies. If you sold, received, or gifted any NFTs during the 2021 tax year, you’ll be required to check ‘Yes’ on the ‘crypto tax question’ on Form 1040.
Because NFTs are designated as digital assets like Ethereum and Bitcoin, NFTs are technically treated as a form of property for tax purposes. Like all property, NFTs are subject to capital gains/losses when you sell the property.
Capital Gains
Capital gains are broken into two categories, short term capital gains and long term capital gains.
Short Term Capital Gains
If you sell an NFT within the first 12 months of receiving it or buying it, you’ll be subject to the short-term capital gains tax rate. This tax rate can be anywhere from 10% - 37% of your gains, depending on your personal income tax bracket.
Long Term Capital Gains
If you sell a NFT after holding it for more than 12 months then you are subject to long term capital gains tax which ranges from 0%-20% depending on your tax bracket.
Here are some contextual examples that can help determine what taxes need to be paid.
Example 1:
You bought $100 worth of Ethereum, the value of your Ethereum went up to $500, you then buy a NFT with all of your Ethereum, and you still hold the NFT.
In this case you would owe $400 in capital gains tax from the Ethereum gains.
Example 2:
You buy a NFT for $100, then you sell the NFT for $10
You would have $90 of capital loss that can be used to offset any capital gains.
Example 3:
You buy a $500 NFT with fiat currency, and then hold the NFT and do not sell it.
You owe nothing on taxes for this transaction
Example 4:
You buy $1000 worth of Ethereum, your Ethereum lowers in value to $500 and you buy a $500 NFT. This NFT airdrops another NFT with a $1000 floor price at the time of drop that you keep and hold in your wallet.
You would have $500 of capital losses on the Ethereum sale, and you would have $1000 in capital gains tax for the airdropped NFT. This would sum up to $500 of capital gains due.
Income tax rate
As mentioned earlier, revenue from NFT sales is taxed as ordinary income for creators, just as any other money made in the year would be.
Ways to Lower NFT Taxes
The question most NFT collectors are likely wondering after going through all the hurdles to determine their taxes due, is how do I lower these taxes? If you're seeking to reduce your NFT tax obligations, consider the following four strategies:
Use fiat currency instead of appreciated cryptocurrency: If you've held onto Ethereum for a while and it has appreciated significantly, using it to buy an NFT could result in a large tax bill. Using fiat currency to make the purchase can be a tax advantage as it does not incur capital gains. Curios transacts most NFT is fiat currency for this reason as well as a few others.
Hold onto your NFTs for the long-term: The longer you hold onto your NFTs (more than 12 months), the lower your capital gains tax rate will be.
Sell your NFTs in a low-income year: If you're in a lower tax bracket due to lower income, you could consider disposing of your NFTs to reduce your tax liability.
Trade wisely: NFTs are subject to different tax rates than other capital assets, so it's important to understand the tax implications of your trading activities.
Additionally don’t forget to think through Tax-Loss Harvesting, Gas Fees, and Play-to-Earn Games
Tax-Loss Harvesting with NFTs:
If you sell your NFTs at a loss, you can claim a capital loss on your tax return. This loss can offset capital gains from other property disposals, such as profits from NFT, crypto, and stock sales, and up to $3,000 of income.
Taxation of NFT Gas Fees:
Gas fees paid to acquire or dispose of an NFT can potentially reduce your tax liability in a disposal event by adding them to your cost basis and/or gross proceeds.
Gas Fee Tax for Buying NFT:
Gas fees related to acquiring an NFT can be added to your cost basis.
Gas Fee Tax for Selling NFT:
Gas fees related to selling or disposing of your NFT can be added to your gross proceeds.
Taxation of NFTs in Play-to-Earn Games:
In-game assets in the form of NFTs are becoming popular in cryptocurrency games such as Axie Infinity. Transactions involving in-game NFTs will likely be subject to the same rules as other NFTs. Buying an NFT with cryptocurrency and selling an NFT within a game will likely be considered disposal events subject to capital gains tax.
Taxation of NFT Airdrops
As discussed in the example above, if you received tokens through an airdrop, you may be wondering about the tax implications. A good and topical example is the Bored Ape Yacht Club airdrop of ApeCoin tokens to any holders of Bored Apes or Mutant Apes, leading to recognition of ordinary income based on the tokens' fair market value during the airdrop.
The same applies when you receive an NFT through an airdrop, and you should recognize it as ordinary income at the time of receipt. To estimate your income, you can look at the fair market value of similar NFTs during the airdrop. For more information on airdrop taxation, we recommend consulting a professional.
Sales Tax on NFTs
If you are an NFT creator who has surpassed the sales tax threshold, it is advisable to consult with a tax professional to ensure compliance with state rules and regulations. It is the creators responsibility to collect and remit sales tax on NFTs, as opposed to buyers and sellers. According to previous Supreme Court rulings, businesses that exceed 200 transactions or $100,000 in sales in a given state are typically required to pay sales tax. Due to the anonymity of web3 this can be impossible to determine what your sales tax burden is, hence our recommendation of consulting with a professional.
Frequently Asked Questions (FAQs) on NFT Taxes
Are NFTs subject to taxation?
Yes, NFTs, like other cryptocurrencies, are considered property and are liable for both income and capital gains taxes.
How are taxes applied to NFT sales?
When you sell an NFT, you will incur a capital gain or loss, depending on the difference between its current market value and the price you originally acquired it.
Do I need to include NFTs in my tax return?
Yes, NFT disposals should be included in your tax return's Form 8949.
Are NFT losses eligible for tax deductions?
Yes, capital losses from NFTs can offset capital gains and reduce your tax liability for the year.
Does the collectible tax rate apply to NFTs?
It’s possible that the IRS will treat certain NFTs as collectibles for tax purposes.
Collectibles are a special type of capital asset, but NFTs are still not technically considered collectibles. The IRS has not issued any official guidance on whether NFTs should be classified as collectibles, so we recommend using a tax professional when possible.
If you are trading NFTs that are classified as collectibles, it is advisable to report all disposals of such collectibles separately on Form 8949, distinct from other capital assets. Each collectible disposal should be added to Form 8949, and the total short-term and long-term gains or losses on collectibles for the year should be summed up.
Because collectibles are subject to different tax rates than other capital assets, completing a separate Form 8949 can facilitate the accurate reporting of capital gains and losses. After computing the total gains or losses on long-term collectibles trading, use the sum to fill out the 28% Rate Gain Worksheet, and report the resulting calculations on Schedule D alongside short-term disposal calculations.