Cryptocurrencies such as Bitcoin and Ether weren’t the only blockchain-based innovations to gain mainstream adoption over the last couple of years. The other new kids on the block are NFTs and NFT transactions.

NFTs, short for non-fungible tokens, are a form of a digital asset stored on the blockchain much like Bitcoin and Ethereum. Unlike traditional cryptocurrency assets, however, NFTs are one of one and are completely distinguishable from one another. Popular NFT collections include Bored Ape Yacht Club, CryptoPunks, and Pudgy Penguins.

With mass adoption came a whole new cohort of NFT creators and investors. As with any new innovation, it’s important to understand how this new industry will impact you from a tax perspective.

When to Recognize Income

The two most common NFT transactions include the sale from the creator and a purchase by an investor. 

The first transaction we’ll cover is the creation and subsequent sale of NFTs. As a creator, you’re responsible for reporting the income generated from the sale of each of your NFTs.

The second type of NFT transaction is the purchase of an NFT. As an investor, it doesn’t matter how the NFT was purchased. Whether the purchase of the NFT occurred on a secondary market or was purchased directly from the creator, the cost basis of the NFT will be the price paid. As an investor, when you go to dispose of the NFT, your gain or loss will be calculated as the sale price less your cost basis.

Post-Sale Income

Less common, though still prevalent, are post-sale income transactions which have tax implications to both investors and creators. 

Creators are most commonly impacted by post sale income from their NFTs when a royalty agreement is attached. For example, a creator may attach a royalty to their NFTs at creation that entitles them to receive 5% of value of each sale of the NFT on the secondary market. This means each time the NFT is sold and changes hands, 5% of the transaction goes to the creator as income. As a creator, you’re responsible for reporting those royalty payments as income.

Investors are most commonly impacted by post sale income from their NFTs when passive income is attached to the NFT. For example, some NFT projects allow the investor to license the use of their NFT to generate income. Each time the NFT licensing fee is paid to the investor, the investor is responsible for reporting the licensing fee as income.

IRS Tax Treatment

Lastly, as an investor, you’ll want to check with your crypto tax CPA on how the IRS classifies the NFT project in which you invested. Not all NFTs are taxed the same; while long and short-term capital gains are typically applied to NFT sales, there’s one caveat. Should the IRS deem the NFT that you purchased and subsequently sold a collectible, it may be subject to the collectibles tax rate of 28%. This is unfavorable when compared to the top long-term capital gains rate of 20%.

How Our Experts at Founder’s CPA Can Help

If you’re looking for seasoned cryptocurrency accountants with experience in the NFT space in Chicago, your search stops with our team at Founder’s CPA. For a risk-free assessment with one of our experts, get in touch with us.

Curt Mastio
Post by Curt Mastio
Nov 22, 2023 4:16:05 PM
Curt Mastio started Founder’s CPA in 2017 and currently serves as the Managing Partner of the firm. After obtaining both his Bachelor’s and Master’s degrees in accounting from the University of Illinois in Urbana-Champaign Curt started his career in Big Four public accounting. Shortly thereafter Curt served as the Chief Financial Officer of Storage Squad began his stint as an Adjunct Instructor at Northwestern University’s Farley Center for Entrepreneurship and has been teaching Accounting & Finance to undergraduate students for 6+ years. In his current role Curt oversees strategy, operations, and business development at Founder’s CPA. Further, Curt has experience working directly with 200+ startups and small businesses providing accounting, tax, and outsourced CFO services. His industry expertise lies in the SaaS, Blockchain, Marketplace, and Fintech industries. He has served as a key advisor working directly with startups that range from pre-revenue to companies generating over $30 million dollars a year in revenue. Lastly, he serves a key role working directly with the firm’s clients that have collectively raised over $200 million in venture capital funding to date. Curt is also an active advisor, mentor, and investor in the startup ecosystem. He has facilitated numerous workshops, webinars, and presentations to incubators and other startup-centric organizations. He is also an active mentor for Techstars in both Chicago and Iowa. Outside of his daily professional duties Curt is actively involved with Beat the Streets Chicago and was a founding member of its Young Professionals Board. His efforts in both leadership and community involvement were recognized when he was awarded the Illinois CPA Society’s Outstanding Young Professional Leadership Award in 2020. He was also a panelist at their annual conference in 2022 where he spoke about his experiences starting and operating a public accounting firm. He maintains an active Certified Public Accountant designation that he obtained in 2014. Outside of work, Curt can be found spending time with his friends & family including his dog Rufus. His hobbies include golf, boating, cooking, reading, and attending sporting events & concerts.