Non-fungible tokens, or NFTs, have become increasingly popular in a number of different industries, including visual arts, sports and entertainment, where they are used to create and market digital collectibles. An NFT is a digital certificate of ownership of a virtual or physical asset which may include products, images, music, videos or other content. Blockchain technology is used to identify and store the asset and track its provenance. Unlike fungible cryptocurrencies, which also use blockchain technology, NFTs are by definition non-fungible, meaning each token is unique. Metadata for storing an NFT typically includes a unique numeric identifier, a description of the asset, and a pointer to an off-chain location where the asset is stored.
Video clips of sports moments and player cards marketed as NFT have already generated billions in revenue for sports leagues, teams and individual athletes. Music, lyrics, sound clips, collaborations and remixes are all popular and lucrative NFT music products. Music and visual arts are combined to create unique NFT artworks with embedded music. Video game companies use NFTs to allow users to buy, trade, and rent in-game assets. NFTs are also used to leverage on-demand visual artwork, e.g. most famous being Christie’s auction of an NFT of a Beeple digital collage, which sold for $69 million.
There are many new legal issues related to the minting, marketing and selling of NFTs. Relevant areas of law include, for example, intellectual property and securities; fight against money laundering and bank secrecy; and tax law, which is the subject of this brief summary. Although the IRS has issued guidelines on the taxation of cryptocurrencies, it has so far not weighed in specifically on the taxation of NFTs. What is clear from the cryptocurrency guidance provided by the IRS is that if an NFT is purchased with cryptocurrency, the purchaser must report a gain or loss on the disposition of the cryptocurrency. So how should the seller of an NFT report it for tax purposes? Actually it depends.
Sales to creators
Because NFTs are intangible assets, the difference between the costs of creating the NFT and the amount received by the creator should be taxed as ordinary income at graduated rates of up to 37% federally, plus income taxes. applicable state income. Sales tax withholding may also apply. The cryptocurrency received by the creator is considered taxable proceeds. If payments for the purchase are made over time, tax on amounts received in the future could be deferred under the installment sale rules. If an NFT buyer decides to resell the NFT, the original creator may automatically receive royalties which would be taxable when received.
Sales to dealers
Dealers who buy and sell NFTs in the normal course of business generally have to recognize ordinary income upon sale because NFTs are considered inventory. Like NFT creators, resellers are allowed to deduct business expenses related to the sale of NFTs, including the costs of acquiring the NFTs, and the net gain would be taxed at graduated rates of up to 37% federal plus applicable state income taxes. A loss on the sale of an NFT by a reseller should be deductible against other income. Even more than the creator, the dealer should be concerned about sales tax withholding issues.
If a company buys an NFT to, for example, promote its products rather than to resell it, the company should be able to amortize the base cost of the NFT, but would be required to “recoup” all or part of any gain. recognized on a subsequent sale of the NFT as ordinary income. The portion of the sale proceeds not subject to recoupment may be eligible for long-term capital gains treatment if the NFT is held for more than one year. In such a case, the long-term capital gain, if not offset by other capital losses, would likely be taxed at a top tax rate of 20% or 21% depending on the type of asset. business entity. A trading loss on the sale of an NFT by a non-concessionaire not offset by gains from the disposal of other trading assets should be treated as an ordinary loss that can be used to offset the taxpayer’s other ordinary income.
Sales to investors
NFTs held for investment purposes rather than in a trade or business should be eligible for capital gains or capital loss treatment on sale. Short-term capital gains not offset by other capital losses would be taxed at the investor’s highest marginal ordinary income tax rate, up to 37% for an individual. If an investor holds an NFT for more than a year, any gains may be eligible for the preferential long-term capital rate. Although the maximum long-term capital gain is currently 20%, NFTs considered collectibles will likely be taxed at a higher tax rate of 28%. Some NFTs may not be considered collectibles, and gains from the sale of such NFTs would be subject to regular capital gains tax rates. However, regardless of this classification, income from the sale of an NFT held for investment purposes would be treated as net investment income and, depending on the taxpayer’s total income, could be subject to a surtax. Additional Medicare 3.8%.
Sales to personal users
Personal-use property is generally defined as property owned that is neither intended for use in a trade or business nor for investment purposes. These assets include those held by individuals for use in a hobby or recreational activity. A taxpayer’s intention should determine whether an NFT is for personal use or an investment. Gains from the sale of NFTs held for personal use would be taxable as capital gains, perhaps in some cases from the sale of a collectible, but losses on the sale would not be deductible. Also, if an NFT for personal use becomes worthless, the loss will not be deductible. The additional 3.8% Medicare surcharge should not apply to earnings from the sale of an NFT held for personal use.
Although the IRS has not yet provided definitive guidance, existing legislation, regulations, and case law generally provide an adequate framework for determining how to treat the purchase and sale of an NFT for tax purposes. As noted, the taxation of NFT sales may vary depending on whether the sale is made by the creator or another holder and on the use of the NFT by the holder. Taxpayers creating, buying, and/or selling NFTs should seek professional tax advice before filing their tax return.
This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Julian A. Fortuna is a partner in Greenspoon Marder’s Corporate and Business Practice Group and focuses his practice on domestic and international taxation, business and estate planning, employee benefits and executive compensation matters. He has considerable experience representing clients in the entertainment, higher education, clean energy, healthcare, hospitality, nonprofit, manufacturing, retail and real estate.
Eric Galen represents top founders, brands, startups and creators and leads Greenspoon Marder’s innovation and technology group, where he leverages his unique experience in corporate, web3, media and entertainment law to help clients to succeed. Eric is also a member of the firm’s Sports and Entertainment Practice Group, as well as its Corporate and Business Practice Group.
Gai Sher is a Senior Advisor in Greenspoon Marder’s Innovation and Technology Group and focuses her practice on representing and advising startups, emerging growth companies, brands, creators and executives in media, technology and consumer products in all aspects of business transactions. She has experience closing deals and structuring rights, talent and production deals in the podcasting industry and other new media spaces.
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