NFT non-replaceable tokens art and collectibles illustration, use blockchain technology to create unique digital items for crypto art, crypto collectibles and crypto gaming.
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The NFT craze can come with a painful tax surprise for buyers and sellers using cryptocurrencies, according to tax experts.
Sales of NFTs, or non-replaceable tokens, have exploded in recent weeks, reaching more than $ 500 million by 2021, according to NonFungible.com. In addition to selling the $ 69 million Beeple NFT titled ‘Everydays: The First 5,000 Days’ at Christie’s last week and the $ 3 million NFT sneakers, NFTs have everything from NBA highlights videos to Jack Dorsey tweets, created a huge new market of blockchain. -based digital assets to buy and sell.
Still, experts say buyers and sellers are likely unaware of an Internal Revenue Service tax rule that could haunt them – and cost them a large chunk of their profits. It poses a high potential burden on anyone using their highly valued cryptocurrency to buy NFTs, which experts say are the most NFT sales.
“People’s knowledge of this tax in the US is very low,” said Shehan Chandrasekera, head of tax strategy at CoinTracker, a crypto wallet and tax tracking platform. “I just don’t think people know about it.”
These are recent IRS guidelines on using cryptocurrencies to buy assets, including an NFT. As part of the principle known as “disposal of assets,” the IRS states that “if you exchange virtual currency held as capital good for other property, including for commodities or for another virtual currency, you will have a capital gain or loss. will acknowledge. “
Chandrasekera said this has major ramifications for the NFT craze, largely fueled by collectors using bitcoin or ether to buy NFTs. For example, if someone bought a unit of ether for $ 100 in 2018, it would be worth about $ 1,700. If they were to use that ether unit to buy an NFT of $ 1700, they could assume they are not paying tax on the ether because they are just using it to buy a good or service.
“EVERYDAYS: THE FIRST 5000 DAYS” is a collage, by digital artist BEEPLE, being auctioned at Christie’s, unknown location, in this undated handout obtained by Reuters.
Christie’s Images LTD. 2021 / BEEP | via Reuters
But under IRS rules, the ether is a capital asset and not a currency. Thus, the holder would have to pay tax on the profit of $ 1,600 as part of the NFT purchase, as the act of exchanging for another asset counts as a sale or “disposition.” So, assuming a top capital gain of 20%, they would owe the IRS a tax of $ 320. They may also be liable to state taxes as many states such as New York and California tax capital gains as income. (The rules around additional sales taxes in each state for NFTs are less clear.)
“You don’t spend money, you spend a prized asset,” Chandrasekera said. “So issuing it makes for a taxable event.”
If the NFT buyer later continues to sell or “flip” the NFT for a higher price – which has become popular with NBA highlights videos and Beeple works – the seller would also pay a capital gains tax on each profit. And since NFTs are considered collectibles, they are taxed at the higher collectible capital gain rate of 28%.
In other words, both buyers and sellers of NFTs are likely to face tax assessments that they have not considered when investing in NFTs.
Another problem is inadequate reporting by companies at the center of the NFT boom. The major platforms that buy and sell NFTs, such as Flow by Dapper Labs or OpenSea, can report a sale, but they are unable to report a buyer’s profit on the crypto used for the purchase.
“They don’t know what a buyer originally paid for their Ethereum or bitcoin, they can only report the sale price of the NFT,” Chandrasekera said.
Tax experts say it’s nearly impossible to know the total amount owed or unpaid to the IRS from the NFT boom. Some say it is in the tens of millions, and maybe hundreds of millions.
Granted, NFT buyers who simply buy bitcoin or ether and immediately use it to buy an NFT would not pay any tax. The tax only applies to those who purchase NFTs with crypto that has increased in value since the purchase.
In addition, the rules do not apply to foreign investors in NFTs. For example, the buyer of the $ 69 million Beeple NFT sold at Christie’s last week bears the pseudonym Metakovan and is based in Singapore. Tax experts say that since Singapore has no capital gains tax that would apply, Metakovan would not owe any tax on the prized ether he used to purchase the piece. Had he been a U.S. citizen, he would have owed more than $ 10 million in capital gains tax as part of the purchase.
However, the IRS will get a share of the Beeple purchase. The artist who created and sold the work, Mike Winkelmann, also known as Beeple, owes federal and state taxes on the proceeds, as he is an artist by trade. Depending on the fees paid to Christie’s and MakersPlace, he could owe tens of millions of dollars in taxes, experts say.
When told he could face such a significant tax bill, Winkelmann told CNBC, “Holy sh– that’s a lot of taxes.”