What is Axie Infinity and How is it Taxed?

Since its establishment in early 2018, Axie Infinity has seen its popularity spike to an incredible level over the last year. With fun features and earning opportunities, it’s no wonder many have flocked to Lunacia for some tokenized fun and profit-making. But with big money comes big tax implications, which is what we're here to talk about. Welcome to the ultimate guide for Axie Infinity tax.

What is Axie Infinity?

Axie Infinity is part of a new trend in gaming, called ‘play-to-earn’. This combines cryptocurrency and gameplay and runs through the Ethereum blockchain.

Axie Infinity itself is a digital pet community in which you buy creatures, or ‘Axies’. You take your Axies to battle, explore, and breed with other Axies. The game is developed by Sky Mavis and has an aesthetic clearly inspired by the likes of Pokémon. Despite being framed as an 18+ rated game, there is no clear age-verification process. It's important, therefore, that kids playing the game should be cautioned on the economic side. You thought Fortnite skins were expensive? Axie Infinity takes the money aspect of a game to a whole new level. You'll see what we mean later on.

How do you play Axie Infinity?

To play, you first need to buy three Axie NFTs with Ethereum, which cost around $1,000. This, of course, is very expensive. The developers are aware, so are currently working on creating a free version of the game that is accessible to everyone.

How do you make money on Axie Infinity?

There are two main ways to make money on Axle Infinity, and when we say make money, it can be big big bucks.

Breeding and selling Axies

One large part of the Axie Infinity is breeding. This involves taking any two mature magical creatures and breeding them to create offspring. The baby Axie will inherit all the features from both its parents. If you manage to breed an Axie with rare, unique, or superior characteristics, you could sell it in the marketplace. Some of these go for thousands. For example, there are multiple Axies that have been sold for hundreds of thousands, including Axie #2655 (or Sir Gregory), which went for $819,000.

Selling land

The Axie Infinity world is built on a place called Lunacia (the mainland). Different parts of this virtual mainland are worth more due to their proximity to advantageous features. This is like in real life, kind of, where certain parts of land are more valuable because of their location.

These features include the following:

River, Roads, Nodes, Estate, Distance to the center (Luna’s landing).

In November 2021, an Axie Plot of land sold for 550 ETH, which at the time equaled $2.5 million. That's Beverley Hill's level of expense.

To take a step back and consider why this virtual land is increasing in price, you have to consider two things. Firstly, the user base of the game has increased. Second, there is huge external interest in developing metaverses and digital land — Axie Infinity Land is just one area people have scoped to invest in for the future.

How are you taxed on Axie Infinity?

Now, with these massive profits on the cards, the eyebrows of the taxman have been firmly raised, probably up past their forehead. This is big money.

The IRS considers any crypto-to-crypto transaction a taxable event. Most Axie Infinity are NFTs (such as the Axies themselves). This means even actions that intuition might not see as transactions, such as using potions or even breeding, may result in taxation. Yep, you heard that right — your Axies may get TAXED for getting it on. It’s been a strange couple of years.

To make things clearer for you, let’s go through some of the taxable events you’ll find in the Axie Infinity game.

When you do the following, you have exercised a taxable event:

Selling AXS or SLP on an Exchange

AXS (Axie Infinity Shards) and SLP (smooth love potion) are cryptocurrency (ERC-20) players receive when playing the game. They are primarily used for breeding fees, but they can also be sold on exchanges.

It is a capital gain to make a profit by selling or otherwise disposing of AXS or SLP when its value is higher than when you received it. These earnings should be reported on Form 8949.

Selling Axies or Axie Infinity land

Just like selling another valuable asset, like a house (yes, these things can go for more than a house), you have made a capital gain. You must report the increase between the Axies cost basis (the amount you bought for, including gas and translation fees) and its selling price (the amount you sold it for).

We’ll look at breeding Axies in a second.

For land, this is the same. You take the amount you bought it for (including any relevant transaction fees) and subtract it from the amount you sold it for. This is your realized capital gain.

Purchasing an Axie

As explained before, before starting the game a player must buy 3 Axie NFTs on the ETH blockchain.

If the ETH you used to buy the Axie is worth more than it was worth when you received it, you have realized a capital gain. For example, if you purchased it for 0.5 ETH (worth $1,500) and the value of 0.5 later goes up to $2,500 when you sell the Axie, you have realized a capital gain of $1,000. This value differential must be reported as such on Form 8949 during tax season.

(If you want help with this, you can always use our crypto tax software, by the way)

Breeding Axies

A player must spend AXS and SLP to breed an Axie. This spend is taxable, which means you must pay capital gains taxes on any increase in value in the AXS and SLP from the time you earned it to the time you spent it. This is similar to the example we gave when purchasing an Axie.

However, these breeding costs could be considered transaction fees. If so, you may be able to deduct some or all of these expenses.

Getting a new baby Axie in your wallet is taxed as a crypto-to-crypto transaction. This means it should be reported on your Schedule D. However, determining the cost basis of a newly bred Axie is difficult. Unsurprisingly, the IRS has not given specific guidance on Axie breeding.

How can Koinly help with crypto taxes?

As mentioned throughout this piece, Koinly is a crypto tax tool that calculates your crypto taxes for you, meaning you don’t have to go through the hassle of doing it yourself. Essentially, Koinly does all the boring tasks that would cost you hours and hours sitting at a computer.

As a quick breakdown, here’s a short summary of what Koinly does.

• Converts your transactions into your country’s currency at fair market value (this in itself is a massive time saver).

• Deciphers what activities are taxable and which are not.

• Allows you to submit a clean and accurate report to your tax office.