The latest craze in crypto might have big implications for your tax bill. Learn what NFTs are and how they’re taxed - including with the updated guidance from the IRS around taxing NFTs as collectibles.
You’ve probably seen NFTs pop up in the news in recent months.
Whether you saw Twitter founder Jack Dorsey sell his first tweet for a casual $2.9 million or you saw Beeple sell an NFT for a record breaking $69.3 million, one thing is clear - NFTs aren’t going anywhere anytime soon.
If you’ve got questions about NFTs - you’re not alone. What is an NFT? What does NFT stand for? What does non-fungible even mean? Are NFTs taxed?
NFTs are so new that a lot of crypto investors don’t yet understand them. But you absolutely should before you make an investment. And if you’ve already invested in NFTs? You need to understand what this means for your tax bill.
We’re covering everything from the NFT basics to what your tax office wants to know about them.
What does NFT stand for?
NFT stands for non-fungible token. If you’d like an NFT definition, in technical terms an NFT is a unique and non-interchangeable unit of data stored on a blockchain.
Of course, for most of us, this doesn’t actually help us understand them any better. So let’s break it down.
What is an NFT?
Fungible tokens are easily replaced by another kind of token. Bitcoin is fungible, Ether is fungible, fiat currencies are fungible - you get the point. You can trade one Bitcoin for another and still have the same asset.
An NFT is just like another crypto token in that it exists solely on a blockchain. Most often the Ethereum blockchain, but some other blockchains are slowly implementing NFT support of their own.
Unlike cryptocurrencies though, NFTs are unique - for the most part - in that you can’t trade one for another. We say ‘for the most part’ because this actually depends on the exact NFT you’re buying.
Some artists are releasing one of a kind pieces - like the Beeple piece we mentioned in the introduction. The record-breaking piece, “Everydays: The First 5000 Days” was a singular piece of digital art, created over the course of 14 years. You can think of this as similar to a traditional famous artwork - like a Van Gogh, Picasso or Monet painting.
But other artists are creating collections. You can think of these as more similar to trading cards or other collectibles - like Pokémon cards, comic books or baseball cards. There might be several of a given card, or token, in existence, but their scarcity makes them collectible. CryptoPunk NFTs are a good example of this.
How do NFTs work?
There’s an issue with the analogies we used above. Unlike famous artworks or even other collectibles… NFTs don’t physically exist. In fact, when you buy an NFT, you get a token with a piece of code saying you have ownership over it, but quite often you don’t get much else. This is easier to understand with an example.
Earlier this year, Chris Torres - creator of the Nyan Cat meme - remastered the animation and sold it as an NFT. It sold for $600,000 to an anonymous investor who now owns the animation. Despite this, literally anyone with an internet connection can do a quick Google search, find Nyan Cat and save it to their device. Case in point:
Despite this, we clearly can see the transaction proving ownership of the token on Etherscan here:
This is because unlike a Van Gogh painting or a 1999 first edition holographic Charizard card - you can’t put an NFT in a frame and keep it in your home. While copies of physical art exist in the form of postcards or merchandise, there is only one physical original.
What you’re actually buying then isn’t the art - but a certificate of ownership for a virtual asset.
The artwork is “tokenized”, also known as minting an NFT. This means smart contracts supported by the Ethereum blockchain are used to create a digital certificate of ownership. Like other assets on a blockchain, the records of NFT ownership are public and maintained by thousands of users.
Some smart contracts will have additional benefits for either the artist or the buyer. For example, they may have an agreement in place for the artist to retain a cut of any future sales of the NFT or they may give the buyer the rights to use the NFT in merchandise.
Though the focus on NFTs in mainstream media is currently art - the potential for NFTs and their current uses is far more vast than this. NFTs could change everything from the entertainment industry to the finance industry.
What can NFTs be used for?
They might have hit the headlines recently, but NFTs have actually been around since 2014. The first NFT projects were artwork projects. But CryptoKitties launched in November 2017 and turned into a popular game where users could adopt and trade cats - in the form of NFTs.
The use of NFTs in games to represent in-game assets is becoming more commonplace - if not controversial. Gaming giant Valve has banned the use of NFTs on the Steam platform (mostly as they don’t want a monetized trading platform they don’t get a cut of), while Epic Games and EA have embraced them as the future of the gaming industry.
NFTs are also increasingly popular in the music industry, generating around $25 million in February 2021 alone. Notable music artists tokenizing and publishing their work include Snoop Dogg, Lil Pump, Eminem, Kings of Leon, Grimes, and Mike Shinoda.
Similarly, those in the film industry have jumped on the bandwagon. Quentin Tarantino released 7 NFTs from uncut scenes in Pulp Fiction, while Kevin Smith has announced his latest horror movie will be released as an NFT.
These are the current uses, but the potential for NFTs in the future is vast. In theory, they could be used to tokenize any documents - like a mortgage, a degree, a driving license, and even our birth and death certificates.
NFTs have existed for a relatively long time in the crypto world - since around 2014. They hit wider public awareness in the crypto market in 2017 and exploded into the mainstream in 2021.
Your guess is as good as ours. Some investors believe NFTs are the future of the art market, while other investors want to diversify their crypto portfolio or support an artist they like. Some people just really like memes.
Like the wider crypto market, no one really knows where NFTs will go next. Some investors have made millions while others will inevitably lose out.
Where is the best place to buy and sell NFTs?
If you’ve decided you’d like a slice of the action - it’s pretty easy. There’s hundreds of NFT platforms available now and all you need to access most of them is your chosen ETH wallet. Some of the best NFT platforms and most popular projects include:
OpenSea - buy and sell NFTs, as well as mint your own NFTs (with no gas fees)
Foundation - buy and sell NFTs from a huge variety of artists.
CryptoPunks - one of the oldest and largest NFT projects.
Nifty Gateway - buy and sell NFTs with drops from huge digital artists.
Crypto.com - popular NFT platform within a large, established crypto exchange.
Most tax offices have updated their guidance to say that NFTs are a crypto asset and therefore the same tax rules that apply to your crypto apply to your NFTs - but there are a few specific exceptions to this. In particular, the IRS has now released guidance stating NFTs may be taxed as collectibles instead.
As well as this, the tax you pay may vary depending on whether you’re a buyer, a creator, or a seller. Different rules may apply to creators.
Use the menu on the right to skip ahead to your country’s NFT tax rules.
Is buying an NFT taxable?
If you’re buying an NFT with fiat currency - this isn’t taxable. But what if you bought your NFT with ETH or BTC?
From a tax perspective, using crypto to buy an NFT is a disposal of an asset and the gain from any disposal of a virtual asset is subject to Capital Gains Tax. Let’s look at an example.
You decide you must have an exclusive CryptoKitty, so you buy Transformers-hybrid NFT MegaFlowTron for 250 ETH.
Fortunately, when you originally invested in ETH, the fair market value the day you bought it was $600 for 1 ETH. $600 x 250 gives you a total of $150,000 for your cost basis.
On the day you disposed of your ETH by spending it on your NFT, 1 ETH was worth $3,000. $3000 x 250 = $750,000.
To figure out your capital gain or loss, subtract your cost basis from your proceeds.
$750,000 - $150,000 = $600,000. You’d pay Capital Gains Tax on $600,000 related to this transaction.
Is selling an NFT taxable?
Yes. But the rules vary a little depending on where you live and whether you're the original artist or just selling on an NFT you purchased as an investment.
In most countries, if you're a seller, when you sell a digital asset like an NFT, you’ll pay Capital Gains Tax on any profit you make from it. If you’re also the artist - this might be seen as income and subject to Income Tax instead.
In most countries, this rule will apply regardless of whether you’re selling your NFT for crypto or for fiat currency - but there are a couple of specific exceptions to this rule, like in France, so check your country’s crypto tax rules.
As well as this, for US investors, the IRS has recently issued guidance that states NFTs may be deemed collectibles under tax laws - and, you guessed it, collectibles have a less favorable tax treatment as the long-term rate (for NFTs held more than a year) is 28% on any gain. Of course, NFTs have a wide variety of use cases we've highlighted above - so not all NFTs are collectibles and the IRS recognizes this. Although this update is immediate, so you may have to pay the 28% collectibles tax on any gain from selling an NFT immediately, the IRS is assessing whether an NFT should be treated as a collectible on a case-by-case basis, stating, “Until additional guidance is issued, the IRS intends to determine whether an NFT is treated as a collectible by using a “look-through analysis".
Is swapping an NFT taxable?
Some NFT platforms let you trade one NFT for another - like trading cards. This is viewed as a disposal of an asset - like swapping one crypto for another - so it’s subject to Capital Gains Tax.
Like the above, only the profit made from any swap will be subject to Capital Gains Tax.
Is minting an NFT taxable?
What if you want to make an NFT or many NFTs? This process is known as minting, just like you’d mint a crypto coin.
Lots of platforms like OpenSea, Rarible, and Binance let you mint NFTs now and the good news is that creating an NFT isn’t a taxable event. It’s only when you sell, swap, or sometimes gift the NFT that you’ll have a taxable event.
Many crypto investors have seen the NFT boom as a new opportunity to make money, especially with the dawn of DeFi. This is what’s known as farming NFTs. It’s similar to liquidity mining and yield farming in that investors deposit an asset into a pool and receive some kind of reward in return.
For example, Ark Gallery is a DAO (Decentralized Autonomous Organization) for CryptoPunks. As these CryptoPunk NFTs are extremely rare and valuable, that makes them inaccessible to the majority of investors. However, Ark lets investors crowdfund together to buy a given CryptoPunk NFT and then own a fraction of the token. They can then later vote on whether to sell it later if there’s an offer.
This is just one example of many. There’s also NIFTEX, SuperFarm, NFTrade, $MEME, and many more. Because each platform works slightly differently, the tax rules on them get complicated to say the least.
If you’re staking an asset and earning a reward like another cryptocurrency or a given NFT in return, this could be viewed as income by many tax offices. So the rewards you receive may be subject to Income Tax.
Meanwhile, if you’re depositing an asset and receive a token in return to represent your share of the pool, this could be viewed as similar to a swap. You’re exchanging one asset for another - this would make it subject to Capital Gains Tax.
The IRS has released updated guidance on NFTs as of March 2023 - but it's a little confusing so let's break it down.
The latest IRS guidance states that NFTs may be deemed collectibles under tax laws. Currently, this means NFTs that represent an underlying “collectible item” will be taxed as such. The IRS has special tax treatment for collectibles which tends to be less favorable, with a long-term tax rate of 28% vs. the long-term rate for other capital assets which is a maximum of 20%. So if you sell an NFT you've held for more than one year that is deemed a collectible by the IRS, then you'll pay 28% tax on any gain from that transaction. For NFTs held less than a year, the same short-term Capital Gains Tax rates apply.
Of course, not all NFTs are collectibles as there's a wide variety of use cases - and the IRS recognizes this. The IRS is soliciting feedback for this latest guidance, and states that "until additional guidance is issued, the IRS intends to determine whether an NFT is treated as a collectible by using a “look-through analysis".
This means the IRS will "look through" the NFT to the underlying asset the NFT represents to determine whether it's a collectible or not, as already outlined by Section 408(m)(2) of the tax code, which states that the following assets are deemed collectibles for tax purposes:
Any work of art,
Any rug or antique,
Any metal or gem (with limited exceptions),
Any stamp or coin (with limited exceptions)
Any alcoholic beverage, or
Any other tangible personal property that the IRS determines is a "collectible" under IRC Section 408(m).
In other words, although this guidance applies immediately, the IRS will be deciding whether NFTs are taxed as a capital asset or collectible on a case-by-case basis by looking at the underlying asset the NFT represents. In their own example in the current guidance, the IRS states, "an NFT is treated as a collectible if the NFT's associated right or asset falls under the definition of collectible in the tax code. For example, a gem is a collectible under section 408(m); therefore, an NFT that certifies ownership of a gem is a collectible."
Whilst the update is helpful in clarifying the IRS approach to NFT taxes, it does raise questions such as whether digital art can be a collectible. The current definition of collectibles implies that they must be tangible. Additionally, there can be multiple use cases for a single NFT such as personal enjoyment, access to events, and investment. The IRS is currently soliciting feedback to resolve some of these queries.
So, in summary, you should use the existing guidance and guidance on collectibles to determine the tax treatment of your NFT. But here's a brief overview.
The CRA hasn’t yet issued any specific guidance on tax on NFTs. However, it’s safe to assume that like most other tax offices, NFT tax will follow existing crypto tax rules.
Canada is a little different than other tax offices though. Crypto is subject to either Income Tax or Capital Gains Tax. But it all depends on how you’re trading and at what scale as to whether you’re taxed at a lower Capital Gains Tax rate or at your normal Income Tax rate. The CRA decides this on a case by case basis - but if you’re trading NFTs to make money, there is a good chance you’ll pay Income Tax instead of Capital Gains Tax.
This said, for those trading, the tax rules on NFTs in Canada are:
Buying an NFT with fiat currency: Not taxable.
Buying an NFT with cryptocurrency: Capital Gains Tax.
Selling an NFT for crypto or fiat currency: Capital Gains Tax.
Swapping an NFT for another NFT: Capital Gains Tax.
Making sure you track any fees relating to acquiring or disposing of your NFT to add to your cost basis
Holding onto your NFTs for more than 12 months to benefit from the lower long-term Capital Gains Tax rate
How Koinly deals with NFT Tax
Koinly is a crypto tax calculator that simplifies crypto and NFT taxes. All you need to do is import your crypto transactions and it calculates your capital gains, losses, income, and expenses in one simple tax summary.
You even can view your NFTs straight from your Koinly dashboard.
Once you’ve added your NFT transaction(s), Koinly calculates the proceeds, gains or losses and adds it to your tax report.
You can download specific tax reports for your local tax office in Koinly. For example, the IRS Form 8949 and Schedule D, HMRC Capital Gains Summary or the ATO myTax report.
Koinly supports NFTs for most EVM-based blockchains and we're always adding more support. Read our full guide on how to add NFTs and troubleshoot any issues.