What NFT Creators Need to Know About Taxes | ASKramer Law

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The tax­a­tion of non-fun­gi­ble tokens (NFTs) is still some­thing of a mys­tery. All we have to go on is the IRS def­i­n­i­tion of dig­i­tal assets and Notice 2023–27. The IRS dig­i­tal asset def­i­n­i­tion includes NFTs, stat­ing that they are a “dig­i­tal rep­re­sen­ta­tion of val­ue which is record­ed on a cryp­to­graph­i­cal­ly secured dig­i­tal ledger or any sim­i­lar tech­nol­o­gy.”[1] Notice 2023–27 sug­gests that cer­tain NFTs are taxed as “col­lectibles.”[2]

Even with­out any more gov­ern­ment guid­ance, the tax treat­ment of NFT cre­ators should be fair­ly straightforward.

Peo­ple who cre­ate NFTs by record­ing the tokens on a blockchain are often referred to as cre­ators, and they include major com­pa­nies, artists, musi­cians, celebri­ties, influ­encers, ath­letes, sports fans, col­lec­tors, and authors. Some­times cre­ators mint NFTs for fun, but NFTs offer cre­ators an oppor­tu­ni­ty to devel­op, mar­ket, and con­trol the future of many types of dig­i­tal con­tent. Using blockchain also allows them to posi­tion their prod­ucts for the future metaverse.

When a cre­ator mints an NFT, it should not, under any tax prin­ci­ples, be a tax­able event. The cre­ation of an NFT does not arise from or rep­re­sent the sale or exchange of prop­er­ty.[3] By anal­o­gy, under the IRS analy­sis for con­vert­ible cryp­tocur­ren­cy set out in Notice 2014–21, an NFT is like­ly to be taxed as prop­er­ty.[4] The cre­ator should thus have a tax­able event when an NFT is sold or exchanged for real cur­ren­cy, cryp­tocur­ren­cy, a dig­i­tal token, anoth­er NFT, or any oth­er prop­er­ty. (When a buy­er pays for an NFT using prop­er­ty, rather than real cur­ren­cy such as the U.S. dol­lar, the trans­ac­tion is taxed as a “barter trans­ac­tion.” As a result, the buy­er, not just the sell­er, has a tax­able event upon the transaction.)

Determining if an NFT is Taxed as an Ordinary or Capital Asset

Whether an NFT sale trig­gers ordi­nary or cap­i­tal gain or loss turns on whether the NFT is an ordi­nary or cap­i­tal asset in the hands of the cre­ator. There are two pos­si­ble ways in which an NFT could be an ordi­nary asset in the hands of its creator.

First, an NFT is like­ly to be an ordi­nary asset if the NFT result from the creator’s per­son­al efforts or it is pre­pared or pro­duced for the cre­ator. An NFT is an ordi­nary asset if it is “a patent, inven­tion, mod­el, design (whether or not patent­ed), a secret for­mu­la or process, a copy­right, a lit­er­ary, musi­cal, or artis­tic com­po­si­tion, a let­ter or mem­o­ran­dum, or sim­i­lar prop­er­ty.”[5]

The sec­ond way in which an NFT is like­ly to be treat­ed as an ordi­nary asset is if it is part of the creator’s stock in trade, of a kind of prop­er­ty includ­ed in inven­to­ry, or held for sale to cus­tomers in the ordi­nary course of the creator’s trade or busi­ness.[6] The eas­i­est way for a cre­ator to fall into this cat­e­go­ry is for the cre­ator to be in the busi­ness of sell­ing NFTs to customers.

Let’s look at the tax impli­ca­tions of NFT cre­ators sell­ing their NFTs to cus­tomers. A recent press release tout­ed a new “box office” for Super Tick­ets.™ Sports Illus­trat­ed Tick­ets has part­nered with “Web3 leader Con­sen­Sys” to sell such tick­ets to sport­ing, music, and the­ater events “pow­ered by Polygon’s blockchain tech­nol­o­gy.”[7] The plat­form allows “own­ers, orga­niz­ers and hosts the abil­i­ty to cre­ate, man­age, and pro­mote the sale of a wide range of tickets.”

Own­ers, orga­niz­ers, and hosts of events who sell tick­ets in the form of NFTs to cus­tomers should receive ordi­nary income under Code §1221(a)(1). More­over, the ordi­nary and nec­es­sary expens­es paid or incurred by such own­ers, orga­niz­ers, and hosts in car­ry­ing on the trade or busi­ness of cre­at­ing and sell­ing tick­ets in the form of NFTs should be deductible.[8] Those expens­es would include the costs of cre­at­ing the NFT, adding the NFT to a blockchain, and all expens­es incurred for the sale of the NFT. The creator’s tax basis would be deter­mined by ref­er­ence to costs and expens­es incurred in cre­at­ing the NFT.[9]

What Happens When Creators Sell or Exchange NFTs?

A cre­ator real­izes gain or loss upon the sale of an NFT. The amount of the gain or loss is the dif­fer­ence between the val­ue of the cash or prop­er­ty received and whether the tax sales amount is more or less than the taxpayer’s adjust­ed tax basis in the NFT.[10]

Rules for com­put­ing the amount of gain or loss are con­tained in Code §1001 and the reg­u­la­tions issued under that sec­tion. As intan­gi­ble assets, the tax basis of cer­tain NFTs can be amor­tized but it is not avail­able to cre­ators of NFTs.[11] Only NFT hold­ers who have acquired those NFTs for sale or exchange in their trade or busi­ness can amor­tize their basis in the NFTs. This does not apply to cre­ators of NFTs.

When the Installment Method or Licensing and Royalties Apply

In an install­ment sale, the sell­er of the prop­er­ty receives at least one pay­ment in a tax year after the sale occurs.[12] Report­ing income on the install­ment method might be avail­able to NFT cre­ators who meet the require­ments for install­ment report­ing. These require­ments are set out in Code §453 and the reg­u­la­tions issued under that sec­tion. As an ini­tial mat­ter, the sell­er can­not be a deal­er and the NFTs can­not be inven­to­ry. Thus, the cre­ator is not eli­gi­ble for the install­ment method if the cre­ator is a deal­er or the NFTs are inventory.

Some or all of the copy­right and intel­lec­tu­al prop­er­ty rights asso­ci­at­ed with an NFT are often retained by the cre­ator. This means that an NFT’s meta­da­ta will include infor­ma­tion about copy­right own­er­ship, license fees, and the sit­u­a­tions when and whether any roy­al­ties are due. As a result, an NFT pur­chas­er only obtains the copy­right or oth­er intel­lec­tu­al prop­er­ty if the rights were explic­it­ly trans­ferred to the pur­chas­er as part of the NFT purchasers.

To encour­age sec­ondary mar­ket trans­ac­tions, more NFT cre­ators are trans­fer­ring some or all of the license and roy­al­ty pay­ments to sub­se­quent pur­chasers. When the NFT cre­ator receives roy­al­ties and license fees as addi­tion­al rev­enue, these amounts are ordi­nary tax­able income.[13]

[1] https://www.irs.gov/businesses/small-businesses-self-employed/digital-assets

[2] The IRS defines col­lectibles in Inter­nal Rev­enue Code §408(m). Exam­ples of col­lectibles include art, rugs, antiques, met­als, gems, stamps, coins (with cer­tain excep­tions for gold, sil­ver, and plat­inum coins), alco­holic bev­er­ages, musi­cal instru­ments, his­tor­i­cal objects, or oth­er tan­gi­ble per­son­al prop­er­ty defined by the IRS.

[3] Code §§61(a)(3), 1001.

[4] 2014–16 I.R.B. 938.

[5] Code §1221(a)(3)(A).

[6] Code §1221(a)(1).

[7] “Sports Illus­trat­ed Tick­ets Part­ners with Con­sen­Sys to Launch ‘Box Office,’ An All-New Self-Ser­vice Event Man­age­ment Plat­form and Pri­ma­ry Blockchain Tick­et­ing Solu­tion Pow­ered by Poly­gon” (May 2, 2023).

[8] Code §162.

[9] Code §1221(a)(3)©.

[10] Treas. Reg. §1.61-(a).

[11] Code §197.

[12] Code §453(b).

[13] Code §1221(a)(3).

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