The NFT market has soared to $44 billion, according to data from Chainalysis, and the rules around token taxation are unclear.
It’s one of the hottest coins in crypto – and now the US government wants its share of the profits.
Investors and creators of non-fungible tokens – a market that has soared to $44 billion, according to Chainalysis data, and which has attracted fans from Justin Bieber to Melania Trump – face billions of dollars in taxes and at rates of up to 37%, according to tax experts. Internal Revenue Service officials who deal with tax evaders say they are preparing for a crackdown.
The surprises looming for NFT enthusiasts when tax season begins this month are the latest wake-up call from Washington crypto as US government officials look to the booming industry. The rules around token taxation are unclear, leaving NFT collectors scrambling to work out how much they owe. Investors may not realize that they have to pay taxes or have to file more than once a year, which increases the risks that they will face future penalties.
“You can’t fail to report gains or losses because the IRS hasn’t provided guidance that meets your expectations,” said San Francisco-based tax attorney James Creech. “The harder it is for people to come to a reasonable – or ideally, right – conclusion, the easier it is to ignore it.”
NFTs have captured attention as representations of digital art and are expected to be a key part of the so-called metaverse that tech titans like Mark Zuckerberg say is the future of the internet. Tokens are digital certificates of authenticity and cannot be replicated, potentially increasing their value.
Token sales skyrocketed last year, with NFTs such as CryptoPunk #3100 – which features an alien wearing a headband – selling for $7.7 million after an initial price of $2,000 in mid-2018. 2017. “Everydays: the First 5000 Days” by digital artist Mike Winkelmann, also known as Beeple, sold for $69.3 million.
Like so much else in the crypto space, tokens are hard to compare to more traditional investments, and regulators, including those at the IRS, are wondering how to control them.
When a creator sells an NFT on a platform like OpenSea or Rarible, most tax experts agree that the profits should be considered ordinary income and subject to a rate of up to 37%. Investors who buy the tokens must pay capital gains taxes if they used another cryptocurrency for the purchase, and when they sell it.
Beyond that, the rules are vague. One wonders whether tokens should be taxed as “collectibles” of art, which come with a long-term capital appreciation rate of up to 28%. This is compared to 20% for most cryptocurrencies and stocks. The infrastructure bill that President Joe Biden signed into law last year will make it harder for people to hide digital assets, but the Treasury Department hasn’t said whether that includes NFTs.
It’s hard to calculate exactly how much tax is owed, but experts like Arthur Teller, COO of TokenTax, estimate that the total NFT tax bill could be in the billions. Some people don’t know they owe quarterly taxes and may already be facing penalties for simply filing an annual return, said TokenTax co-founder Zac McClure. Other people probably don’t know there are reporting requirements, said Shehan Chandrasekera, head of tax strategy at CoinTracker.
With so much money at stake, the IRS will likely be forced to clarify the rules, but it could start by auditing people, said Michael Desmond, the former IRS chief counsel who is now a partner at Gibson. Dunn & Crutcher.
IRS investigators are preparing for a possible increase in cases as early as this year.
“We will likely see an influx of potential NFT-type tax evasion, or other cases of crypto-asset tax evasion, down the road,” said Jarod Koopman, acting executive director of cyber and forensic services at the Criminal Investigations Division of the IRS.
In the meantime, NFT aficionados should be prepared for a lot more paperwork.
“It’s an absolute nightmare,” said Adam Hollander, an NFT investor and creator of the “Hungry Wolves” collection, adding that he spent 50 hours going through months of trades. “There are people who won’t want to do what I do.”
–With help from Beth Williams.