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.
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.