While people are busy making a killing buying and selling NFTs, tax obligations are often overlooked. Taxes are not the most fun thing to do, but keeping track of what you owe is one of the hallmarks of a successful investor, NFTs and crypto included. And, as the NFT space grows, so does the risk of falling afoul of your own country’s particular rules and regulations which is turning an increasing amount of attention to crypto investing.
We’ve created this NFT tax guide then to help you know why you need to pay tax on NFTs and what your responsibilities are.
Why do I need to Pay Taxes on NFTs?
Whether you are creating your first NFT, selling your hundredth, or you’re trading an NFT for another, all of these events involve the disposal of assets that may have appreciated in value. Either cryptocurrency or the NFT itself.
Just as with any other form of investment, appreciations in value are taxable events. In the eyes of most world governments, it doesn’t matter if the asset exists in the form of a physical collectible or in the Ether, distribution across the blockchain. If you have made a measurable gain on your investment, you are liable to pay taxes on it.
The first to clear up 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 held the asset.
- If you held the crypto or NFT for less than one year (365 days), the asset is subject to short-term capital gains tax.
- If you held the crypto or NFT for more than one year (366 days+), the asset is subject to long-term capital gains tax.
In the US, at least, the tax rate of NFTs remains something ambiguous. The IRS has yet to formally announce the tax status of non-fungibles, but they are more than likely considered “collectibles.” Tax experts point to the IRS’ definition of collectibles as “any work of art.”
This means NFT trading is subject to capital gains tax.
Unfortunately, as a collectible, NFTs carry a 28% top federal tax rate, which is higher than the 20% of stocks, bonds, and even cryptocurrencies.
In some countries, like the U.S., a difference is made between hobbyists and professional creators. Creating NFTs for fun or for profit carries different tax responsibilities.
Professionals would treat profits as income rather than capital gains.
Creating NFTs almost universally triggers taxable events. Minting, listing, and selling your NFTs on platforms such as OpenSea involves the disposal and transacting of cryptocurrencies and NFTs at multiple stages.
Minting an NFT involves paying gas fees. This triggers a taxable event as you are disposing of cryptocurrency to pay the network fees involved in interacting with blockchains like Ethereum.
The rationale behind this is that the cryptocurrency you are using to pay the network fees may have appreciated in value in the time you’ve owned it.
While your gas fees may only be 0.02 ETH, the value of the cryptocurrency could have been significantly less when you exchanged fiat currency for it. In today’s market, that 0.05 ETH may be worth around $150. But, at the time of exchange, it may have only cost you the equivalent of $75.
In paying 0.05 ETH to mint an NFT, you effectively dispose of 0.05 ETH and generate a capital gain. In this case, $75 worth.
Selling your NFT typically puts you into the professional category and therefore means profits are taxed as ordinary income (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 rate of tax differs depending on how long you held the NFT.
For example, if you create an NFT and go on to sell it for 1 ETH ($3500) the very next day, paying $150 in fees. The $3350 profit is subject to short-term capital gains tax according to the ordinary income tax rate.
Most platforms allow NFT creators to collect ongoing royalties in perpetuity. This, too, is taxable.
After tallying up your royalties, the value in fiat is classed as ordinary income that needs to be reported.
NFT investors are people who buy and sell non-fungible tokens for profit. This activity is considered a source of income and subject to taxes too.
One activity that is often overlooked by investors in terms of tax is purchasing NFTs with fungible crypto.
This is classed as a taxable event because it involves disposing of cryptocurrency in order to make the purchase. As the crypto may have gained value in the interim, governments want to make sure that this profit is taxed too.
- Scenario 1: You bought some ETH today to make the purchase. The ETH lost 5% of its value before purchasing an NFT. Not taxable.
- Scenario 2: You bought some ETH today to make the purchase. The ETH gained 5% of its value before purchasing an NFT. Taxable according to short-term capital gains.
- Scenario 3: You bought some ETH 2 years ago. The ETH has gained 200% of its value before purchasing an NFT. Taxable according to long-term capital gains.
Selling your NFT for crypto incurs a capital gain or loss based on how much money you made or lost in the trade.
If you bought an NFT for $5,000 worth of ETH (your “cost basis”) and then proceeded to sell it for $12,000, your taxable capital gains are $7,000 ($12,000 – $5000).
Trading NFTs also incurs taxes.
For example, buying an NFT for $1000 worth of ETH and then trading it for another which appreciates in value to $10,000 in the following months. This would incur a capital gain of $9.000, as the original swapped assets are assumed equivalent value.
Staking NFTs is treated the same as mining or getting paid in cryptocurrency. In other words, if the rewards for staking have an equivalent cash value, they are taxed at the ordinary income tax rate (10-37% in the US).
How to File NFT taxes?
Each country will have its own systems for filing taxes and the treatment of NFTs. Using the US as an example, these are the forms that are most relevant to 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 cryptoexchanges, details your profits and losses for each coin you can input into form 8949. (https://www.irs.gov/forms-pubs/about-form-1099-b)
1099-K: also issued by cryptoexchanges, details monthly activity including gross profits. (https://www.irs.gov/forms-pubs/about-form-1099-k)
1099-Misc: issued by cryptoexchanges if you receive more than $600 worth of additional income through staking etc. (https://www.irs.gov/forms-pubs/about-form-1099-misc)
1040: contains a section pertaining to the selling, exchanging, or otherwise disposing of any financial interest in any virtual currency. General dealing with crypto tends to mean filling this form section out is necessary. (https://www.irs.gov/forms-pubs/about-form-1040)
Despite being daunting at first, keeping your NFT taxes in order ensures fewer headaches down the road.
Not reporting your earnings from crypto and NFTs is considered tax evasion in most countries, with nations like the UK and US dealing with severe penalties. Failing to report your NFT and crypto gains could land you a 20-70% fine should you be audited discrepancies be found.
The simplest thing is to follow the advice in this NFT tax guide and keep ahead of your obligations, setting aside tax owed and keeping proper records. While cryptoexchanges now tend to issue cost-basis information on capital gains, NFT platforms are lagging behind, so it’s worth recording everything yourself.
For the serious investor, there are app and software solutions that can streamline the process, or you can employ the help of a tax advisor experienced with crypto investing.