Non-fungible tokens (NFTs) have made a big splash in the investing world over the past few years. In 2021, NFT sales hit a whopping $17.6 billion, according to data from NonFungible.com and L'Atelier BNP Paribas. An NFT is a unique digital token that represents the ownership of an original piece of digital property, such as a virtual collectible, piece of artwork or even a tweet.
The potential to profit from NFTs raises one obvious question for investors: How are NFTs taxed? As with most other assets, NFT gains are usually taxable. While the IRS hasn't explicitly addressed the NFT investment space, it can be safely assumed they'll be treated like any other virtual currency profits. Here's how taxes work on NFTs that you purchase, sell or gift to others.
How NFT Taxes Work
Are NFTs taxable? The short answer is yes, but things get murky when trying to pin down how NFTs are taxed in the eyes of the IRS. Assuming NFTs are taxed as property like cryptocurrencies such as Bitcoin, you'll need to report gains and losses on your annual tax return. When you profit from a virtual currency or NFT, the IRS will expect a cut. Your tax rate is determined by how long you held the asset, along with your taxable income. On the flipside, you can generally deduct losses to offset capital gains.
Taxes When Buying NFTs
NFTs can be purchased in a variety of ways. Ethereum is the leading platform for NFT sales and the largest NFT marketplace is OpenSea. Content creators generate and store original pieces of digital art on the Ethereum blockchain. Investors then buy and sell them in a marketplace, and the tech allows for secure, authentic record-keeping around transaction histories and rights of ownership.
Some marketplaces may allow you to pay in cash, but cryptocurrency is the standard form of payment. What's more, most NFTs can only be purchased in their native cryptocurrency—Ether in the case of NFTs that use the Ethereum blockchain, for example.
Purchasing an NFT with traditional currency will not trigger a tax liability, but it's a different story when buying with crypto. Since you're using one form of property to buy another, you may owe taxes if the cryptocurrency you're using to make the purchase has risen in value since you acquired it.
If it's appreciated and you've held it for a year or less, you'll likely pay short-term capital gains tax. This is the same rate charged on your ordinary income. Long-term capital gains, on the other hand, are often taxed at a lower rate.
One other thing: Collectibles are subject to a higher capital gains tax rate. If you purchase an NFT piece of art that falls in this category, long-term capital gains could be as high as 28%. It's something to keep in mind if the NFT appreciates and you eventually sell it.
Taxes When Selling NFTs
Investors who sell NFTs are likely in for similar treatment from the IRS. Once you buy an NFT, it becomes your property and you can sell it to the highest bidder if you choose. If you turn a profit, you'll be charged either short- or long-term capital gains tax, depending on how long you held the asset. Again, losses can also be reported on your tax return. If your losses outweigh your gains, you can deduct up to $3,000 from your taxable income ($1,500 for married folks filing separately).
NFT sales are taxed differently for non-investors. When content creators and digital artists sell original NFTs, they'll be expected to report the money as income on their tax return. They'll also be on the hook for paying self-employment taxes and quarterly estimated taxes. The upside is that such self-employed people can also deduct qualified business expenses to reduce their taxable income.
Are NFT Gifts Taxable?
If you receive an NFT as a gift, you will only be taxed if you choose to sell it later for a profit. If you are gifting an NFT to someone else, know that U.S. taxpayers enjoy an annual gift tax exclusion that works out to $16,000 per recipient in 2022. There's also a lifetime exclusion amount of roughly $12 million as of 2022. If the total value of your gifts to one person, including NFTs, exceeds $16,000 during this calendar year, you'll have to report the difference on your tax return.
How to Limit Taxes on NFTs
- Hold on to your NFTs for at least a year. Again, long-term capital gains rates are generally more favorable. Depending on your income and filing status, you might pay 0%, 15% or 20% over the long term. Short-term rates, on the other hand, can be as high as 37%.
- Pay in fiat currency if possible. The term "fiat currency" refers to traditional, government-backed currency like U.S. dollars. Paying for NFTs with cryptocurrency triggers a taxable event—not so if you pay with cash.
- Plan ahead if you're a content creator. Self-employed folks who fail to meet their tax obligations could face hefty penalties and a steep tax bill. If you're in this camp, plan ahead to avoid unwanted financial surprises.
The Bottom Line
Navigating the relatively new world of NFTs can be confusing, especially where taxes are concerned. Time will tell how the IRS ultimately handles these assets, but for now it looks like they'll be treated as property (or, in some cases, collectibles). If you're not sure how to include NFT sales and profits in your tax filing, consult a tax professional.