While non-fungible tokens (NFTs) have exploded in popularity over the past year, the Internal Revenue Service (IRS) has yet to provide guidance on the tax treatment of these digital assets. With Tax Day right around the corner, this presents challenges for NFT creators and investors. Even without IRS guidance, U.S. taxpayers must still do their best to comply with the law, as Maryland tax lawyer Kevin E. Thorn, Managing Partner of Thorn Law Group, discusses below.
Will NFTs Qualify as “Property” for Federal Income Tax Purposes?
As with cryptocurrencies and other digital assets, a fundamental question with regard to federal income tax compliance is how the IRS classifies NFTs. The IRS adopted a policy of treating cryptocurrencies as property (as opposed to currency) in 2014, but it has not yet provided specific guidance with regard to NFTs.
Given the IRS’ long-standing policy on cryptocurrencies and the nature of non-fungible tokens, it is likely that the IRS will also treat NFTs as property for income tax purposes. As noted in a recent article published by the Journal of Accountancy, “Even more than ‘cryptocurrency,’ which the IRS regards as property distinct from fiat, or ‘real’ currency, NFTs bear some traditional hallmarks of property.” But, whether taxpayers should make this assumption is a matter they will need to discuss with their tax professionals on a case-by-case basis.
NFTs May Qualify as Ordinary or Capital Assets
Another key issue related to NFTs is whether these assets trigger ordinary or capital gains or losses. Both are possible under different scenarios.
The sale of an NFT is likely to trigger ordinary income for the creator in most cases. There are two main reasons why. First, an NFT will qualify as an ordinary asset if it represents, “a patent, invention, model, design (whether or not patented), a secret formula or process, a copyright, a literary, musical or artistic composition, a letter or memorandum, or similar property.” These are all excluded from the definition of a capital asset under Section 1221 of the Internal Revenue Code (IRC).
Second, for creators, NFTs may also represent, “stock in trade . . . or other property of a kind which would properly be included in the inventory of the taxpayer.” Inventory assets are also excluded from the definition of capital assets under Section 1221.
For investors, on the other hand, NFTs are most likely to qualify as capital assets. Similar to other types of capital assets, whether NFT investors owe short-term or long-term capital gains tax will depend on whether they held their NFTs for a year or longer. Since NFTs are intangible assets, investors should be entitled to amortize their adjusted basis under Section 197 of the IRC.
Discuss Your NFT Tax Obligations with Maryland Tax Lawyer Kevin E. Thorn
Maryland tax lawyer Kevin E. Thorn, Managing Partner of Thorn Law Group, provides strategic tax advice for digital asset creators and investors. He also represents individuals and businesses in IRS audits and investigations. To discuss your NFT-related tax obligations with Mr. Thorn in confidence, please call 240-235-5096, email ket@thornlawgroup.com or get in touch online today.
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