How Do NFT Taxes Work?

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2021 was the year of the non-fungible tokens (NFTs) drawing in thousands of crypto aficionados, which skyrocketed their trading volumes. But, let’s not forget that NFTs aren’t just a ruse. NFT investors have made serious money and some have even become multimillionaires in mere months.

Keeping the earnings aside, NFT investors are still seen asking for help across social media in search of tax guidance. While wallets and platforms such as MetaMask, OpenSea, and Phantom make NFT trading very easy, they don’t provide any information concerning NFT taxes at the time of the transaction. In this guide, we shine some light on NFT taxes and various scenarios that trigger a taxable event.

How Are NFTs Taxed?

While investing in NFTs there may be three main taxable events:

Event no.1: Paying with ETH

NFTs are mainly purchased using Ether (ETH) and this transaction is considered as a capital gain/loss. First, you have to sell the ETH for fiat (creating a taxable event) and then buy the NFT using the fiat. You’ll have to pay taxes on price appreciation from when you first bought ETH to when you sold it to buy the NFT. Therefore, the IRS sees NFT transactions as a simultaneous sale of an asset (ETH, SOL, or ADA) to purchase a new asset (NFT) resulting in capital gain or loss.

Event no. 2: Selling or Swapping the NFT

If you sell your NFT to buy ETH or exchange it for another NFT, it is also a capital gains/loss taxable event. Similar to the first event, the IRS sees it converting your NFT into fiat and then buying back the ETH or another NFT with the fiat currency. You’ll be liable to pay NFT taxes on the price appreciation of the ETH from first buying the NFT and then selling it. So, there’s a possibility that you might sell your NFT for less and book a loss but still owe taxes because ETH’s prices increased from the time you bought the NFT.

Event no.3: Back to Fiat

After buying back ETH from the NFT sales and then selling the ETH for fiat currency is obviously a taxable event. If the ETH prices went up from the time you bought it, then you will be taxed on the profits you booked.

 

NFT Taxes for Creators

 

Taxes work differently for NFT creators as compared to NFT investors. Creating an NFT doesn’t create a taxable event, but selling it in an exchange in return for a crypto token or other compensation would. For instance, If an NFT creator creates a digital collectible and sells it for ETH on OpenSea, it will be considered as an ordinary income for the creator. Here, if the creator doesn’t convert the ETH for fiat currency immediately, a new capital gains holding period begins for the received ETH.

NFT Taxes on Airdrops

 

What if you’re airdropped an NFT because you held the original just like the Bored Ape Yacht Club holders got a Mutant Ape NFT?

 

In this scenario, the IRS has issued very little guidance, but based on the question above, such airdrops will be taxed as ordinary income when generally the assets enter your wallet and/or are recorded on the ledger. If you don’t claim the asset, you won’t be taxed as you don’t have control over it, but if and when you sell the airdrop, it will be subjected to capital gains tax.

NFT Taxes on Receiving NFTs as Gifts

 

If you receive NFTs as gifts, it is most likely a non-taxable event. But, the donor will likely have to pay “gift tax” if the value of the gift is above $16,000 and they have to fill the IRS form 709. If you sell the received gift, you’ll owe capital gains tax and the cost basis will be determined at the price at which the first buyer bought it.

Final Thoughts

 

NFTs have become wildly popular in the last couple of years. While tax guidelines on cryptocurrencies are still murky, the NFT market has surely added some difficulties for the IRS to issue clear guidelines on their taxation.

FAQs

1. What is NFT in Crypto?

 

NFT stands for non-fungible token and it is usually created using similar programming as cryptocurrencies such as Bitcoin to Ethereum. NFTs are one-of-a-kind cryptographic tokens that exist on a blockchain network and cannot be copied. NFTs represent real-world items like real estate and artwork.

 

2. Do I have to pay tax on my NFT?

 

Yes, you have to pay taxes on your NFTs. If you buy an NFT using ETH then you have to pay taxes on the sale of ETH because it is considered as selling an asset. If you swap NFTs, you again have to pay taxes because it involves selling ETH in the process. And, if you sell an NFT for fiat currency then you have to pay taxes as well.

3. Why are NFTs so expensive?

 

NFTs are expensive because they are authentic non-fungible assets and that’s why the assets are unique. Picasso’s paintings are a good example. His paintings are non-fungible because the original paintings are irreplaceable and unique even if someone can make copies of them.

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