Art illustration and collectibles of non-fungible tokens from NFT, use blockchain technology to create unique digital items for cryptoart, cryptocollectibles and crypto-games.
holly harry | iStock | Getty Images
According to tax experts, NFT fashion can bring a painful tax surprise for buyers and sellers who use cryptocurrencies.
Sales of NFTs, or non-consumable tokens, have exploded in recent weeks and topped $ 500 million in 2021, according to NonFungible.com. Along with the sale of the $ 69 million NFT Beeple titled “Everydays: The First 5,000 Days” at Christie’s last week and the $ 3 million NFT sneakers, the NFTs of everything from featured NBA videos to in Jack Dorsey’s tweets, they have created a new blockchain market – Digital Assets based on buying and selling.
However, experts say buyers and sellers are unaware of a Internal Revenue Service tax rule that could haunt them again and cost them a large portion of their profits. It involves a heavy tax on anyone who uses their highly valued cryptocurrency to buy NFT, which according to experts is the majority of NFT sales.
“People’s knowledge about this tax in the United States is very poor,” said Shehan Chandrasekera, head of fiscal strategy at CoinTracker, a platform for tracking cryptocurrencies and taxes. “I don’t think people know that.”
At issue are recent IRS recommendations on the use of cryptocurrencies to buy an asset, including an NFT. As part of its principle known as “asset disposal,” the IRS states that “if you exchange virtual currency that is held as a capital asset for other assets, including assets or another virtual currency, you will recognize a capital gain or loss. “
Chandrasekera said this has important implications for NFT fashion, which is being fueled largely by collectors who use bitcoins or ether to buy NFT. For example, if someone bought an ether unit for $ 100 in 2018 and it would be worth about $ 1,700. If they used this ether unit to buy a $ 1,700 NFT, they could assume they don’t pay taxes on ether because they simply use it to buy a good or service.
“EVERYDAYS: THE FIRST 5000 DAYS” is a collage, made by digital artist BEEPLE, that is at auction at Christie’s, an unknown location, in this undated document obtained by Reuters.
Christie’s Images LTD. 2021 / BEEP | via Reuters
But by IRS rules, ether is a capital asset, not a currency. Therefore, the holder would have to pay income tax of $ 1,600 as part of the purchase of NFT, as the act of exchanging it for another asset counts as a sale or “disposition”. Therefore, they would owe the IRS, assuming a 20% higher capital gains rate, a $ 320 tax. They may also owe state taxes, as many states such as New York and California tax capital gains as income. (The rules on additional sales taxes in each state for NFT are less clear.)
“Don’t spend money, you’ll spend a prized asset,” Chandrasekera said. “So just spending it creates a taxable event.”
If the NFT buyer later sold or “turned around” the NFT at a higher price, which has become popular among prominent NBA videos and Beeple works, the seller would also pay a capital gains tax for any gain. And since NFTs are considered collectible, they are taxed at the highest collectible capital gain rate of 28%.
In other words, it is likely that both NFT buyers and sellers will face tax bills that they did not take into account when investing in NFT.
Another problem is inadequate reporting by companies at the center of the NFT boom. Large platforms that buy and sell NFTs, such as Flow from Dapper Labs or OpenSea, may report a sale, but are unable to report a buyer’s earnings on the cryptography used for the purchase.
“They don’t know what a buyer originally paid for their Ethereum or Bitcoin, they can only report the sale price of the NFT,” Chandrasekera said.
Tax experts say it is nearly impossible to know the full amount to be paid or not paid to the IRS from the NFT boom. Some say it’s tens of millions, and maybe hundreds of millions.
Of course, NFT buyers who simply buy bitcoins or ether and use it instantly to buy an NFT would not face any tax. The tax only applies to those who buy NFT with encryption that has increased in value since its purchase.
In addition, the rules do not apply to foreign investors in NFT. The buyer of the $ 69 million Nep Beeple that was sold to Christie’s last week, for example, goes by the pseudonym Metakovan and is based in Singapore. Tax experts say that since Singapore does not have a capital gains tax to apply, Metakovan would not have owed taxes on the prized ether he used to buy the piece. If he had been a U.S. citizen, he could have owed more than $ 10 million in capital gains tax as part of the purchase.
The IRS, however, will get its share of the Beeple purchase. The artist who created and sold the work, Mike Winkelmann, who also goes through Beeple, will have to pay federal and state income taxes, as he is an artist by profession. According to the fees paid to Christie’s and MakersPlace, it could owe taxes of tens of millions of dollars, experts say.
When told he could deal with such a large tax bill, Winkelmann told CNBC, “Holy shit, that’s a lot of taxes.”