While people are busy buying and selling NFTs, tax liabilities are often overlooked. Taxes aren’t the most fun thing to do, but keeping track of what you owe is one of the hallmarks of a successful investor, including NFTs and cryptography. And as the NFT space grows, so does the risk of violating your own country’s specific rules and regulations, driving more and more focus on crypto investments.
We then created this NFT tax guide to help you understand why you should pay taxes on NFTs and what your responsibilities are.
Why do I have to pay tax on NFTs?
Whether you create your first NFT, sell your hundredth, or trade in one NFT for another, all of these events involve the sale of assets that may have appreciated in value. Either cryptocurrency or the NFT itself.
As with any other form of investing, capital gains are taxable events. In the eyes of most world governments, it doesn’t matter whether the asset exists in the form of a physical collectible or in the Ether, distributed on the blockchain. If you have made a measurable profit on your investment, you will owe tax on it.
The first that needs to be clarified is the difference between short-term capital gains and long-term capital gains. In countries like the United States, the tax rate changes depending on how long you’ve owned the asset.
- If you owned the crypto or NFT for less than a year (365 days), the asset is subject to short-term capital gains tax.
- If you held the crypto or NFT for more than a year (366 days+), the asset is subject to long-term capital gains tax.
In any case, in the US, the tax rate of NFTs remains somewhat ambiguous. The IRS has yet to formally announce the tax status of non-fungibles, but they’re more than likely considered “collectibles.” Tax experts point to the IRS’ definition of collectibles as “any work of art.”
This means that NFT trading is subject to capital gains tax.
Unfortunately, as a collector’s item, NFTs have a high federal tax rate of 28%that is higher than the 20% of stocks, bonds and even cryptocurrencies.
In some countries, such as the US, a distinction is made between hobbyists and professional makers. Creating NFTs for fun or for profit involves several tax responsibilities.
Professionals would treat gains as income rather than capital gains.
Creating NFTs almost universally causes chargeable events. Mining, listing and selling your NFTs on platforms like OpenSea involves the removal and transaction of cryptocurrencies and NFTs in multiple stages.
Striking an NFT involves paying gas fees. This causes a taxable event as you are removing cryptocurrencies to pay the network fees involved in interacting with blockchains such as Ethereum.
The rationale behind this is that the cryptocurrency you use to pay for network fees may have increased in value over the time you owned it.
While your gas costs may be as little as 0.02 ETH, if you had exchanged fiat currency for it, the cryptocurrency’s value could have been significantly lower. In today’s market, that 0.05 ETH could be worth about $150. But at the time of the trade, it may have cost you only the equivalent of $75.
By paying 0.05 ETH to strike an NFT, you essentially have 0.05 ETH and generate a capital gain. Worth $75 in this case.
Selling your NFT typically puts you in the professional category and that means profits are taxed as ordinary incomee (between 10-37% in the US).
This is because selling an NFT for crypto or even exchanging it for another is also considered the disposal of an asset. Again, the tax rate differs depending on how long you held the NFT.
For example, if you create an NFT and sell it the next day for 1 ETH ($3500), you’ll pay $150 in fees† The $3350 profit is subject to short-term capital gains tax at the ordinary rate of income tax.
Most platforms allow NFT creators to collect ongoing royalties forever. This is also taxable.
After adding up your royalties, the value in fiat is classified as ordinary income that must be reported.
NFT investors are people who buy and sell non-fungible tokens for a profit. This activity is considered a source of income and is also subject to taxes.
One activity that is often overlooked by tax investors is buying NFTs with fungible crypto.
This is classified as a taxable event as it involves removing cryptocurrency to make the purchase. Since the crypto may have appreciated in the meantime, governments want to make sure that these gains are taxed as well.
- Scenario 1: You bought some ETH today to make the purchase. The ETH lost 5% of its value before buying an NFT. not taxable†
- Scenario 2: You bought some ETH today to make the purchase. The ETH gained 5% of its value before buying an NFT. Taxable according to short-term capital gains†
- Scenario 3: You bought some ETH 2 years ago. The ETH gained 200% of its value before buying an NFT. Taxable according to long-term capital gains†
Selling your NFT for crypto produces a capital gain or loss based on how much money you have made or lost in trading.
If you bought an NFT for $5,000 worth of ETH (your “cost basis”) and then sold it for $12,000, your taxable capital gains would be $7,000 ($12,000 – $5,000).
Trading in NFTs is also taxable.
For example, buying one NFT for $1000 worth of ETH and then trading it for another that increases in value to $10,000 in the following months. This would yield a capital gain of $9,000 since the original assets exchanged have an equivalent value.
Betting NFTs is treated the same as mining or getting paid in cryptocurrency. In other words, if the staking rewards have an equivalent cash value, they are taxed at the normal income tax rate (10-37% in the US).
How to file NFT taxes?
Each country will have its own systems for filing taxes and handling NFTs. Taking the US as an example, these are the forms most relevant for filing NFT taxes.
8949-Schedule D: Used to report the gains and losses made using cryptocurrencies and NFTs. (https://www.irs.gov/forms-pubs/about-form-8949)
1099-B: Issued by crypto exchanges, details your gains and losses for each coin you enter in Form 8949. (https://www.irs.gov/forms-pubs/about-form-1099-b)
1099-K: also issued by crypto exchanges, details monthly activity including gross profit. (https://www.irs.gov/forms-pubs/about-form-1099-k)
1099-Miscellaneous: Issued by crypto exchanges if you receive more than $600 in additional income through staking etc. (https://www.irs.gov/forms-pubs/about-form-1099-misc)
1040: Contains a section related to selling, bartering or otherwise disposing of financial interests in virtual currencies. General handling of crypto usually means filling out this form section is necessary. (https://www.irs.gov/forms-pubs/about-form-1040)
Despite being daunting at first, keeping your NFT taxes in order means fewer headaches down the road.
Failure to report your crypto and NFT income is considered tax evasion in most countries, with countries like the UK and US facing severe penalties. Failure to report your NFT and crypto gains could result in a 20-70% fine if controlled discrepancies are found.
The easiest way is to follow the advice in this NFT tax guide and stay ahead of your obligations, set aside tax due and keep good records. While crypto exchanges now tend to release fee-based information about capital gains, NFT platforms are lagging behind, so it’s worth capturing everything yourself.
For the serious investor, there are app and software solutions that can streamline the process, or you can enlist the help of a tax advisor experienced in crypto investing.