Non Fungible Tokens, also popularly known as NFTs, are witnessing amassive wave of growth. NFTs became more popular in the investment scene in 2021, and they have taken the world by storm with such enormous acceptance. Finder reports that NFTs had a massive sales volume of $2.5 billion. Nansen also noted that the NFTs have fast become valuable assets.
All these attest to the fact that the interest in NFTs continues to enjoy massive growth, which can be traced to the fact that there is an increase in transactions that go on in the cryptocurrency market. Moreover, the sales recorded serves as an impetus for many other creators to display their NFTs for possible sale in NFT marketplace like Nifty Gateway.
Interestingly, the successes recorded by artists in the NFT space have now gained the attention of the tax authorities, who are always on the lookout for means to gain more revenue into the government coffers. For instance, the US Internal Revenue Service and the Australian Taxing authority pay keen attention to the NFT investment activities. Though there is no concrete framework to evaluate many of these investment activities, it is currently a work in progress.
Hence, it is essential that you have in-depth knowledge and understanding of your tax position, liabilities and duties as an NFT investor. In this article, you will learn what NFTs entail, the various types of taxes imposed on NFTs by tax authorities, and situations where taxes are charged in an NFT transaction.
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What are NFTs?
NFTs are digital assets and serve as certificates of ownership rights. These assets are very unique and valuable among many tokens. They can rarely be duplicated. For instance, you can exchange one Bitcoin for another Bitcoin. Each will be worth the same value.
But it is entirely different for NFTs. This is unique because artists, musicians and creators can now convert digital arts into NFT. This way, artists can take records of their ownerships of digital arts and validate their authenticity. There is also a massive money-making opportunity that is accrued to trading NFTs. We can safely attest to the fact that NFTs have risen into a multibillion-dollar industry.
How Do NFTs Work?
NFTs are designed such that they are verifiable through a blockchain ledger. This is what characterizes the unique nature of NFTs. Indeed, NFTs was initially launched on the Ethereum blockchain before other blockchains like Bitcoin Cash and FLOW came into the scene. So, it is immaterial whether or not the original file is a JPG, MP3 or GIF. All that matters is that the NFT that takes note of its own can be sold and bought like any other kind of art.
Notably, the price of an NFT is usually determined by the market demand. This is similar to what is obtainable when physical art is sold. For instance, a digital collage that is themed "Everdays: The First 5,000 Days" was sold for $69 million.
This sale was initiated by Michael Winkelmann, a famous digital artist, also known as Beeple. He is also the maker of the collage. But when the deal was initiated by the NewYork Times as an NFT, it was sold for $560 000 in 2021, precisely in March. Thus, it was sold as determined by the market.
Are NFTs taxed?
Yes! In many instances, NFTs are taxed. They are under the tax system like fungible cryptocurrencies. Thus, if you are an investor who earns money from NFT sales, it is important that you prepare your tax report on the proceeds. When an investment is made in NFTs, the profits will be considered assets, and they will be subject to the CGT regime. However,the following are the most taxed NFT activities:
● Procuring an NFT via fungible cryptocurrency
● Sales of NFT for cryptocurrency
● Making trades of an NFT for another NFT tax
Tax Structure for NFT investors
There are few taxable activities to be considered for NFT investors as compared to what obtains for NFT creators. Taxable activities for creators are absolutely devoid of any ambiguity. While creating an NFT does not necessarily translate into an NFT activity, it is when you sell NFTs on NFT Marketplace like Rarible that you may be liable to pay taxes on the gains of the sale. These gains will be highlighted as your income, and it automatically becomes subject to income tax.
Thus, these profits will be taxed by an ordinary-income rate. These rates vary from 10% to about 45%. This income is also subject to self-employment taxes set at personal tax rates. The case is different for NFT investors.
Some of the activities that will be subject to Capital Gain Tax for investors are as follow:
A. Procuring an NFT with a Fungible Token like Ethereum
When you purchase NFT with a cryptocurrency, this means that a disposal of assets has occurred. Thus, this will bring about a profit or loss. For instance, if you buy an NFT trading card on Rarible using an appreciated Ethereum, you will profit from the disposal. However, you will be liable to pay taxes on the profits.
You may be liable to pay either long-term or short-term capital gains tax. This depends on how long the Ethereum holds before purchasing an NFT with it. However, buying an NFT trading card using a depreciated Ethereum will mean a loss. The loss will be used to cancel your other capital gains liability. However, this reduces your tax liability.
B. Selling an NFT in Exchange for Another
When you trade an NFT in exchange for another, it creates another taxable activity for an investor. For instance, if you buy an NFT for $3,000 worth of ETH and you sell it for NFT afterwards for $4,000 worth of ETH, you will be making capital profits of $1,000. These profits are therefore taxable under capital gains.
C. Trading an NFT in Exchange for Cryptocurrency
This is another taxable activity NFT investors should know about. When you trade your NFT for cryptocurrency, you either make a loss or gain. Where you make a gain in such sales, you will be liable to pay taxes. The taxes are called capital gains tax.
How are NFTs taxed?
While it is evident that the IRS has not given a clear-cut framework that will guide the administration of tax for NFTs, one can still safely assume that NFTs may likely receive the same tax considerations as cryptocurrency. This means that NFTs will be taxed as property at a long-term capital gains tax rate, ranging from 0-45%, depending on your income. On the other hand, NFT could also be taxed in the similitude of stamps, trading cards, or antiques for personal use.
However, the difference is only brought to the fore if the assets are held for over a year. Thus, if you sell any NFT after a holding for a period of less than a year, it will be placed under a short-term capital gains tax rate (which is equal to ordinary rates of income tax). This happens irrespective of whether they are seen as collectibles or property. Bloomberg reports that investors are expected to report file taxes on NFTs.
Thus, the investors can report the disposal of cryptocurrency. This is used to buy NFTs. This is also used to subsequently sell NFTs on Form 8949 (Sales and other Disposition of Capital Assets) and Schedule D (Capital Gains and Losses). However, it is important to indicate the disposal of a collectible by entering code "C."
As stated earlier, there is sufficient information that gives a clear-cut mechanism in the Cryptocurrency scene. Thus,you may not generally get 1099 forms that highlight the cost basis details from NFT marketplaces. So, it is imperative for you to keep the records of the market value details and cost basis information of the cryptocurrency that is used to buy NFTs, and also records of the NFTs. This information is essential because it helps calculate your capital gains and their commensurate taxes accurately.
Whether you are an NFT creator or an NFT investor, it is very important to know the tax implications of NFT transactions. Calculating and tracking NFT taxes will become more complicated as you progress in your transactions. Unfortunately, many NFT marketplaces do not give transaction reports. Even if they do, some of these forms do have cost basis information.
Therefore, it is important that you keep records of both the cryptocurrency used to purchase NFTs and the NFTs. However, you can make the process seamless and easy for you by using a cryptocurrency tax automation system such as Crypto tax calculator and Koinly to track your gains and losses, calculate profits and losses, provide and issue your tax forms and determine your tax liability in record time. Alternatively, you can make it easier by consulting with us and letting us advise you on these to ensure your tax record remains pristine and keep you out of reach of authorities and their regulations.
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