NFT non-fungible art and collectible art illustration uses blockchain technology to create unique digital items for cryptographic art, crypto-collectables and cryptographic games.
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The NFT craze may come with a painful tax surprise for buyers and sellers who use cryptocurrencies, according to tax experts.
Sales of NFTs, or non-fungible tokens, have exploded in recent weeks, reaching $ 500 million in 2021, according to NonFungible.com. Along with the sale of the $ 69 million Beeple NFT titled “Everydays: The First 5,000 Days” at Christie’s last week, and the $ 3 million NFT sneakers, NFTs of everything from top NBA videos to tweets from Jack Dorsey, have created a vast new blockchain market based on digital assets for purchase and sale.
Even so, experts say buyers and sellers are probably unaware of an IRS tax rule that can come back to haunt them – and cost them a large portion of their earnings. This involves high tax potential on anyone who uses their highly valued cryptocurrency to buy NFTs, which experts say are the majority of NFT sales.
“People’s knowledge of this tax in the United States is very poor,” said Shehan Chandrasekera, head of tax strategy at CoinTracker, a platform for tracking cryptographic portfolios and taxes. “I just don’t think people know that.”
At issue is the recent guidance from the IRS on using cryptocurrencies to buy an asset, including an NFT. As part of its principle known as “asset disposal”, the IRS states that “if you exchange a virtual currency held as a capital asset for another property, including assets or another virtual currency, you will recognize a capital gain or loss.”
Chandrasekera said this has important implications for the NFT craze, which is being largely fueled by collectors who use bitcoin or ether to buy NFTs. For example, if someone bought a unit of ether for $ 100 in 2018 and it would be worth about $ 1,700. If they used this ether unit to buy a $ 1,700 NFT, they can assume that they do not pay taxes on the ether, as they are simply using it to buy a good or service.
“EVERYDAYS: THE FIRST 5000 DAYS” is a collage by a digital artist BEEPLE, which is being auctioned at Christie’s, an unknown location, in this undated handout obtained by Reuters.
Images from Christie LTD. 2021 / BEEP | via Reuters
But, according to IRS rules, ether is a capital asset, not a currency. Therefore, the holder would have to pay a $ 1,600 gain tax as part of the purchase of NFT, since the act of exchanging it for another asset counts as a sale or “sale”. Therefore, they owe the IRS – assuming a maximum capital gains rate of 20% – a tax of $ 320. They may also owe state taxes, as many states like New York and California tax capital gains as income. (The rules on additional sales taxes in each state for NFTs are less clear.)
“You are not spending money, you are spending a valued asset,” said Chandrasekera. “So just spending it creates a taxable event.”
If the NFT buyer later sells or “reverses” the NFT at a higher price – which has become popular with videos of NBA highlights and Beeple works – the seller would also pay a capital gains tax on any winnings. And since NFTs are considered collectible items, they are taxed at the highest rate of collectible capital gains of 28%.
In other words, both buyers and sellers of NFTs are likely to face tax bills that they did not consider when investing in NFTs.
Another problem is the inadequate reporting of companies at the center of the NFT boom. Large platforms that buy and sell NFTs, such as Flow by Dapper Labs or OpenSea, can report a sale, but cannot report the buyer’s gain on the encryption used for the purchase.
“They don’t know how much a buyer originally paid for their Ethereum or bitcoin, they can only report the selling price of the NFT,” said Chandrasekera.
Tax experts say it is almost impossible to know the total amount owed or not paid to the IRS with the NFT boom. Some say it is in the tens of millions and perhaps hundreds of millions.
It is true that NFT buyers who simply buy bitcoin or ether and use them instantly to buy an NFT face no tax. The tax applies only to those who buy encrypted NFTs whose value has increased since the purchase.
Furthermore, the rules do not apply to foreign investors in NFTs. The buyer of the $ 69 million Beeple NFT that was sold at Christie’s last week, for example, goes by the alias Metakovan and is based in Singapore. Tax experts say that since Singapore does not have a capital gains tax applicable, Metakovan would not have owed the appreciated ether tax he used to buy the piece. If he were an American citizen, he could have owed more than $ 10 million in capital gains taxes as part of the purchase.
The IRS, however, will play a part in the purchase of Beeple. The artist who created and sold the work, Mike Winkelmann, who also works for Beeple, will have to pay ordinary federal and state income taxes on profits, since he is an artist by profession. Depending on the fees paid to Christie’s and MakersPlace, he could owe tens of millions of dollars in taxes, experts say.
When informed that he could face such a significant tax bill, Winkelmann told CNBC: “Geez, that’s a lot of taxes.”