August 31, 2021
NFT stands for Non-fungible Token.
Physical money and cryptocurrencies (such as Bitcoin or Ethereum) are “fungible,” meaning they can be traded or exchanged for one another. These items are equal in value. Crypto’s fungibility makes it a trusted means of conducting on the blockchain (also known as a digital ledger).
NFTs are different. A non-fungible token is a unit of data stored on a blockchain, that certifies a digital asset to be unique and therefore not interchangeable. NFTs can be used to represent items such as:
So, although anyone may be able to download an image file of a CryptoPunk (popular NFT project), each NFT project can have one contract address and each specific NFT has a unique ID. While copies of these digital items are available for anyone to obtain, NFTs are tracked on blockchains to provide the owner with a proof of ownership that is separate from copyright.
Earlier this year CryptoPunk 7804 sold for $7.57 Million.
NFTs are likely treated as “collectibles” under tax code Section 408(m)(2). Although the IRS has not issued any NFT specific tax guidance yet, according to the Section 408(m)(2)(A) “any work of art” is considered a collectible.
The taxation of NFTs depends on two interactions:
Creators are the artists who create NFTs and offer them for sale in a marketplace. Creators encounter a taxable event when they sell NFTs.
Investors are individuals who buy and sell NFTs for investment opportunities. Generally, most people fall into this category.
For NFT investors, taxes are like those for cryptocurrency trading. NFTs are often purchased using cryptocurrencies. Purchasing an NFT using Ethereum triggers a taxable event because you are disposing of a cryptocurrency, which is treated as a property per IRS Notice 2014-21.