Did you buy, sell, donate, or receive an NFT during the tax year? If so, you must answer “yes” to the digital assets question on page one of the IRS Form 1040. Additionally, if you have sold an NFT, you could be liable for tax or eligible for a deductible loss.
If you are unsure what an NFT is, it stands for non-fungible token, meaning each NFT is unique. NFTs differ from Bitcoin and other forms of cryptocurrency in that they are non-interchangeable with other crypto or real currency. They are digital certificates of ownership for virtual or physical assets, such as digital art, collectibles, music, virtual real estate, etc.
In Notice 2023-27, the IRS said, for the time being, it will treat NFTs that are tax-law-defined collectibles as collectibles for tax purposes. This is important for the following reasons:
If you sell a collectible held for more than one year, your maximum capital gains tax rate is 28 percent, whereas other assets have a maximum of 20 percent.
If you have your individual retirement account (IRA) or stock bonus, pension, or profit-sharing plan buy a collectible, you are deemed to have taken a taxable distribution that is subject to ordinary income taxes and early withdrawal penalties.
The tax code defines a collectible as any work of art, rug or antique, metal or gem, stamp or coin, or any alcoholic beverage.
You buy and sell NFTs online. You typically buy NFTs using cryptocurrency, namely Ethereum. When you exchange Ethereum for an NFT, you recognize a capital gain or loss. Your later sales of NFTs also trigger capital gains or losses.
NFTs are considered non-capital assets in the hands of their creators, and hence, when sold, creators receive ordinary income. Donations of NFTs to charity result in a charitable deduction for the purchaser, but donations by NFT creators hold little value.
Additionally, personal gifts of NFTs to your relatives and others are not taxable events to the recipients.
If you realize a capital gain or loss from buying or selling an NFT, you report the transaction on IRS Form 8949, Sales and Other Dispositions of Capital Assets. The totals from this form transfer to your Form 1040, Schedule D.
You must track your NFT transactions to report them on your tax return correctly.