How NFT Transactions Can Affect Your Taxes

April 11, 2023
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If you bought, sold, donated or received a non-fungible token (NFT) in 2022, you must answer “yes” on the digital assets questions of your IRS Form 1040. You may also be liable for paying taxes or be able to claim a deductible loss if you sold an NFT last year.

What is an NFT?

NFTs have become extremely popular in recent years. Each one is unique and offers a digital certificate of ownership for virtual assets, such as art, music and virtual real estate. They differ from Bitcoin and other forms of cryptocurrency because they are not interchangeable with other crypto or real currency.

NFTs Defined as Collectible Assets

The IRS stated in Notice 2023-27 that it will treat NFTs as collectibles for tax purposes. This is important for the following reasons:

  • If you sell a collectible held for more than a year, your maximum capital gains tax rate is 28%, whereas other assets have a maximum of 20%.
  • If you use your individual retirement account (IRA) or stock bonus, pension, or profit-sharing plan to buy a collectible, you are deemed to have taken a taxable distribution that is subject to ordinary income taxes and early withdrawal penalties.

The IRS tax code defines a collectible as any work of art, rug, antique, precious metal, gem, stamp, coil or any alcoholic beverage.

Taxable NFT Transactions

NFTs are bought and sold online using cryptocurrency—usually Ethereum. When you exchange Ethereum for an NFT, you recognize a capital gain or loss. Your later sales of NTs also trigger capital gains or losses.

Creators or NFTs are receiving ordinary taxable income when they sell their assets, even if it’s in the form of cryptocurrency. Donations of NFTs to charity will result in a charitable deduction for the purchaser. However, donations by NFT creators hold very little value. Personal gifts of NFTs are not taxable events for the recipients.

Reporting NFT Gains or Losses

It is important to report any NFT transactions that have realized a capital gain or loss. This can be done on IRS Form 8949 (Sales and Other Dispositions of Capital Assets). The totals from this form transfer to your Form 1040, Schedule D. You should track all your NFT transactions for each tax year and report them properly on your tax return.

For more information and guidance on NFT and crypto tax issues for your 2022 or 2023 tax returns, contact Illumination Wealth today.