Non-fungible tokens (NFTs) are becoming increasingly popular. However, with record sales and a slew of new investors, what does this mean for tax season?
There are more opportunities for investors as the NFT world continues its march into the mainstream. However, such possibilities raise serious concerns about regulations and taxes. Already, the industry in the United States is on the verge of new, potentially harmful regulations.
In general, cryptocurrency regulation
Earlier this summer, the Senate passed a bipartisan tax infrastructure bill that included a small crypto-related provision.
Despite its small size, it has a significant impact on the community. The crypto clause broadens the definition of a broker. It categorizes most participants in the space, whether they are investors, developers, or exchanges, into the same reporting category. The simple act of sending crypto to a friend or purchasing a coffee with bitcoin may be subject to taxation.
Nonetheless, there are people in high positions on the crypto side. Among those who spoke out for the community was US Senator Pat Toomy, who called the bill as it stands “unworkable.” The CEO of Coinbase also commented on the bill’s potential negative impact.
While nothing is set in stone, the cryptocurrency community is on edge. Others, such as tZero’s Chief Legal Officer Alan Konevsky, see the impending regulations as a sign of industry maturity.
“Crypto has sort of found itself all grown up all of a sudden, and all of a sudden, we find ourselves in the spotlight of a national political process, in the middle of a very meaningful piece of unrelated legislation, where for revenue generation measures, crypto is relevant because it is grown up and an attractive source of revenue,” he previously told BeinCrypto.
This week, House Democrats in the United States introduced their own crypto tax provisions. While not as industry-shaking as the Senate’s additions, they are still more red tape. Legislators hope to have completed crypto tax infrastructure by the end of September 2021.
However, when most people think of taxing cryptocurrencies, they think of coins like bitcoin or ethereum. What is frequently overlooked is the ERC-721 token, also known as NFTs.
The NFT market is exploding. Pop-culture icons such as Doja Cat now have their own collections. In her case, the NFTs form their own metaverse and range in price from $5 to thousands of dollars. Others, such as the Bored Ape Yacht Club series, auction at prestigious auction houses and earn millions of dollars.
With all of that money comes responsibility. What are the current tax implications for these digital treasures? What must collectors who own a variety of these assets declare?
“The taxation of the NFT creator differs from the taxation of an investor selling an NFT. Ordinary income tax rates and self-employment taxes would almost certainly apply to the creator. “An investor would most likely be subject to collectibles tax rules,” says Edward Kim, tax director at Anchin Accountants and Advisors.
This means that those who create NFTs must pay taxes on the profits they make from selling their creations. Because this is considered income, the taxes mentioned by Kim apply.
Paying tax on NFTs you’ve amassed
According to Kim, there is a distinction between a $10 NFT and one that sells for millions of dollars. The main distinction occurs when the buyer acquires the tokens used in the NFT transaction.
“Purchasing an NFT triggers a realization event based on the sale of the Ether token,” Kim explained.
“Taxation on cryptocurrency sales is based on capital gains tax rates. If a token is purchased and sold within a year, the tax owed will be at ordinary income tax rates for that specific taxpayer, which could range from 10% to 37% depending on the taxpayer’s income tax bracket,” he explains.
The rules are different if the purchaser purchased the token more than a year before the NFT acquisition. The tax obligations of selling the token will then fall under long-term capital gains rates, which could be taxed at 0%, 15%, or 20% depending on their overall tax situation. “Don’t forget about the potential additional 3.8 percent net investment income tax,” he says.
Paying attention to NFT taxes
Kim believes that the average taxpayer and NFT dabbler is unaware of the situation due to the murky situation surrounding overall crypto taxes.
As of now, the IRS and other U.S. regulators have not issued specific guidelines for NFTs. Despite the fact that lawmakers are clearly interested in the space. Meanwhile, Kim advises those involved in the space to be on the lookout for future changes.
“We interpret current tax law and apply it to the taxation of non-financial transactions.” People should be wary that the taxation of NFTs may change in the future based on possible IRS guidance,” he says.