Are NFTs Now Taxable At A Higher Rate? – Fin Tech

Nonfungible Tokens (NFTs) Can Be Artwork

The Internal Revenue Service (IRS) recently issued a notice (the
“Notice”) regarding its intention to provide guidance
related to determining when nonfungible tokens (NFTs) will be
treated as collectibles under the Internal Revenue Code (the
“Code”). This planned guidance would have important
consequences for NFT enthusiasts: collectibles are taxed at a
higher capital gains rate on sale (28%, as opposed to the normal
20%), and Individual Retirement Accounts (IRAs) cannot hold
collectibles as a matter of law. Currently, tax practitioners must
make difficult judgment calls in assessing their clients’ NFT
portfolios and applying old standards to new technologies.

In its most basic form, each NFT represents an individually
exchangeable token that provides the holder with an
“associated right or asset” that is stored digitally and
can be bought and sold on online marketplaces.

An NFT asset for the holder may include:

• a digital image




• a digital sports “moment” (akin to a physical sports
  card)




• a game




• the right to attend a ticketed event; or




• the right to ownership of a plot of virtual land.

For purposes of the Notice, the IRS makes a distinction that it
intends to assess whether an NFT is a collectible by applying a
“look-through analysis” to determine whether the
NFT’s associated right or asset meets the definition of a
collectible under the Code. This means the IRS would ignore the NFT
itself and look to the corresponding right or asset when
determining tax treatment.

Under the current definition of a “collectible” under
the Code, it is reasonable to question whether it must be a
“tangible” item. It is safe to say that NFTs themselves
are not tangible property and do not meet this aspect of the
statutory definition. Nevertheless, it is unclear whether the
holder of an NFT’s associated right to digital art should be
construed as a collectible under the tax law.

Of course, until recently, it was inconceivable that a work of
art selling for thousands of dollars in a marketplace would be
intangible, despite the notion that an NFT may be colloquially
regarded as something that is considered valuable by
collectors.

For most, the practical importance of whether an NFT is treated
as a collectible under the Code stems from its relevance to the
sale or exchange of collectibles. In general, when a collectible is
held for more than one year, it is subject to a maximum 28% capital
gains tax rate, versus the current 20% long-term capital gain tax
rate for other non-collectible capital assets.

The IRS is presently seeking commentary related to its proposed
tax treatment for NFT collectibles. Either way, taxpayers and their
advisors should bear in mind the IRS’s current proposal when
taking relevant positions on tax returns before a final notice is
released.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.