Taxation of Non-Fungible Tokens

A non-fungible token (“NFT”) is a type of digital asset, representing something unique.  Because it is unique, it cannot be replaced by any other item or asset—like a piece of original art (The Mona Lisa), or an original Michael Jordan rookie basketball card.  Something fungible can be replaced with another item.  For example, a Bitcoin can be replaced by another Bitcoin, because a Bitcoin is not unique.  Or a print of the Mona Lisa can be replaced by another print.  But The Mona Lisa itself can never be replaced.  This is like an NFT.

NFTs are unique digital assets, representing value to its creator or holder, just like a piece of tangible art.  An example of an NFT is the very first tweet ever posted on Twitter.  It recently sold for close to $3 million.  While NFTs are a digital asset, like cryptocurrency, they are not cryptocurrency because of their unique properties. 

The IRS has released some guidance on the taxation of cryptocurrency (also called “virtual currency”), but it is not complete and does not address all questions that arise in cryptocurrency transactions.  Differently, the IRS has not yet addressed taxation of NFTs.  That said, there is no reason to believe NFTs will be treated differently than other types of property for tax purposes.

The same taxation principles that apply to pieces of tangible art or collectors’ items likely apply to NFTs.  The CEO of Twitter that sold the first tweet has gain on his sale of the asset and if it was a capital asset in his hands, his gain is subject to capital gains tax rates, as opposed to higher ordinary income tax rates.  If a person purchases an NFT using cryptocurrency, it is a taxable transaction and both parties (seller and buyer) may have a tax consequence.  The IRS has made clear that like-kind exchanges do not apply to cryptocurrency.  Since an NFT is unique such that nothing else is of “like-kind,” it would not fall under that rule anyway, but some taxpayers may believe that because they used a digital asset to purchase another digital asset (an NFT), there is nothing to report on a tax return.  That is not true.

If you are the owner of a collectible car and exchange it for a piece of art with another person, you have a taxable transaction.  The difference between your basis in the car (i.e., generally the cost you paid for it) and the current fair market value of the piece of art results in either a gain or a loss to you. The owner of the piece of art also has a gain or loss.  This transaction is no different than a person using cryptocurrency to purchase an NFT.  There is a tax consequence that must be reported on an income tax return.

If you have questions about taxation of cryptocurrency or NFTs, contact Anderson & Jahde for help.

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