With the recent spike in sales at record-breaking prices, the term ‘NFT’ has managed to gather attention worldwide – What hasn’t gathered as much attention though, is the NFT taxation.
It has been a subject of discussion over social media for the past year with people debating whether it’s a game-changing technology or an internet fad that will die in due course.
We have seen the sale of NFT digital assets at astronomical values in the past year from arts like 3D models of real estate selling for more than a million dollars, or just images of famous internet memes like ‘Disaster girl’ for almost half a million dollars.
Table of Contents
NFT Taxation – Overview
Let’s start this guide with the essentials to know about NFTs, which is instrumental before we move to the following section about NFT tax.
What is NFT?
An NFT or non-fungible token is a digital certificate that shows the uniqueness of a digital asset. It is information stored in a blockchain ledger that can provide proof of ownership of a digital asset like a photo, video, audio or other digital files.
It uses the same blockchain technology that cryptocurrencies uses, however all units of any cryptocurrency are similar.
For example, 1 bitcoin is similar to another bitcoin and can be exchanged with the other. In contrast to that, each NFT is unique and non-fungible with unique value and cannot be recreated.
Musicians, photographers, and other digital art creators are recording their art as NFTs to record their ownership of their art and selling it to make money. The ownership and transfer of NFTs can be verified universally in the blockchain ledger similar to cryptocurrencies.
However, NFTs aren’t like copyrights, and selling a token doesn’t mean the creator cannot produce another copy of the art. In a practical sense, an NFT is like an autographed copy of art in which the token serves as proof of authenticity. Anyone else can still download a copy of the art from the internet, which is why a lot of people are still speculating about the worth of NFTs.
But considering the huge gains people have made in the creation and trade of NFTs, a lot of people are jumping into the game. Thus, it is important to talk about the tax consequences of NFTs because people are trule making an income out of this.
If you’re a photographer looking to get started in the NFT space, be sure to check out this awesome guide: All You Need To Know About NFT Photography.
Tax Treatment of NFTs
Tax authorities around the world are yet to give proper guidance notes on tax treatments of digital assets like NFTs, which has kept creators and traders in A LOT of confusion.
Questions like what will be considered a taxable event, how income tax and/or capital gains tax will be applied are baffling investors and tax practitioners alike.
However, we can still apply the general taxation principles to NFTs in a similar way that it applies to other cryptocurrencies. Generally, the same tax treatments of cryptocurrency will be applicable to NFTs too.
NFTs are likely to be considered as property for taxation purposes like cryptocurrency, making purchase and sale of them a taxable event.
Thus, when ‘trading’ NFTs, ask yourself whether this is done with a professional purpose (are you in the business of selling, creating and dealing NFTs) or is this more so for your personal use and are you simply investing in it in the hopes the value will go up later on?
Depending on your answer it will either be taxed as business income if this is now your main business activity or alternatively, it will trigger personal income or capital gains tax.
Taxation for NFT Creators
The creation of NFTs itself is not a taxable event just as it is the case with any work of art. But when the artist sells the NFT on trading platforms or auctions, he/she will be liable to pay tax on the profit generated on it.
If the artist is in the business of creating and selling NFTs then it is likely that the creator of NFTs will be considered self-employed in the business of creating and selling NFT tokens, they will be taxed at normal income tax slab rate, depending on their total income unless they form a business entity.
And remember, business entities usually attract significantly lower income tax rates than self-employment tax rates ever will, so plan ahead if you’re trying to make a living out of this.
NFT creators will usually be taxed in the same manner as people who mine cryptocurrencies. You can get deductions from expenses incurred when creating the token from your sale value. This means that in some instances, gas fees might be tax-deductible.
Really, from a tax perspective, you’re considered to be in the business of selling NFTs and are therefore a small business owner.
If you don’t have an entity setup then you’ll usually fall into the category of being self-employed. This will attract self-employment taxes and social security contributions as per your country just like any other self-employed person. But if you decided to set up a separate entity then you’ll attract business income taxes.
NFTs also come with contracts that allow the creator a portion of the future earnings of NFTs. Such contracts can be embedded in the blockchain ledger of the token.
The creator might also put in an embedded condition to provide him a part of the future sale of the token. This future sale will also form a part of the taxable income of the creator as his taxable income.
Taxation for Investors in NFT
NFTs are generally traded using cryptocurrencies, hence a lot of time the exchange takes place between two digital assets and no real money is involved.
But nonetheless, they can trigger taxable events, even if you’ve never received any fiat money into your bank account. Same thing is valid when you buy a cryptocurrency for another cryptocurrency.
Taxable events may include:
1. Purchase/Sale of NFT Using Cryptocurrency
Suppose you bought a baseball NFT worth $1000 by exchanging 1 ETH you bought a few years ago for $100. Thus, now you have earned a capital gain of $900 ($1000 – $100) on your 1 ETH as this will be considered as a sale of ETH.
This is because cryptocurrency is not actual currency for the tax department but an asset that you are disposing of in exchange for another asset.
It might also attract long-term capital gain tax rates as you bought the ETH more than a year ago (depends on where you’re living).
The $1000 will be the cost price for the NFT for considering future gains. Now if you sold an NFT on the marketplace at a higher value than you bought it, then you will again incur capital gains on that transaction.
A lot of basketball videos have been selling at a good price on NFT marketplaces and people are earning huge gains. Suppose you sold the NFT at $2000, you will have a capital gain of $1000 ($2000 – $1000). In other words, both buyers and sellers of NFT may have to pay taxes.
2. Exchanging One NFT with Another NFT
Trading one NFT for another will also be a taxable event. Suppose you exchanged the above NFT of $1000 for an NFT valued at $1500 after some time, you will incur a capital gains tax of $500 in this transaction.
3. Earning Royalties in Cryptocurrencies
If you are earning royalties or licensing fees on usage or subsequent sale of NFT as discussed above and get paid in cryptocurrencies, you will still have to pay tax on that income when it occurs on regular income tax rates.
It is not necessary to earn fiat or receive the gains in real traditional currency to pay taxes on them. Nor does the gain ever have to touch your bank account for you having to pay taxes on it.
A lot of people who are not aware of this, will get delayed in payment of their taxes and might be charged huge penalties for it. If you have earned substantial gains from NFT trading, you might also have an obligation to pay advance taxes, failure of which will also attract penalties.
There has not been any clarification as to whether NFTs will be taxed as collectible arts like stamps, antiques, trading cards etc.
In such cases, NFT might attract higher tax rates for long-term capital gains. For short-term capital gains, they will still be taxed according to your income level.
Calculation of NFT Taxes
As shown above, there are many situations where taxes will be applicable in the NFT trade. If you are regularly trading in NFTs especially using cryptocurrency, it will be difficult to keep track of your trades.
Unlike crypto exchanges, where the software allows you to reconcile your purchase and sales and determine costs and gains for taxation, NFT marketplaces do not provide such facilities.
NFT marketplaces can only show the sale value of the NFT, but not the price of the cryptocurrency at which the buyer has bought them.
When you purchase an NFT, it will not be possible for the marketplace to ascertain your gains. If you bought crypto to purchase NFT instantly, then there will not be any gains but if the value of crypto has increased from previous purchases, then you will have to pay tax.
It will be your responsibility to track each purchase and sale and figure out the correct cost and sale value. Each NFT being unique, it wouldn’t be necessary to use cost valuation methods as is the case with cryptocurrencies.
But determining the fair value of NFTs can be problematic. You cannot check their value on exchanges, thus a proper appraisal will be needed to determine their value. If the transaction value is huge, the appraisal can be of significant issue.
There are a couple of Portfolio Valuation Tools out there that will help you keep track of your purchases and sales, as well as the corresponding profits and losses made. So, it can definitely help your accountant with the preparation of your taxes.
Also, if you do need an accountant who is well-versed in crypto / NFT matters please reach out to us and let us know your country of residency. We have a large network of accountants all around the world and are more than happy to make an introduction so that your tax return can be prepared properly.
Tax Savings in NFT for Digital Nomads
Digital nomads can have a severe advantage when it comes to saving on capital gain taxes. If you are based in a country with low or no capital gain taxes, your entire gains from the NFT trades may not attract any tax.
A lot of higher value NFTs have been bought and sold from Singapore-based traders. These traders are avoiding tax on both purchase and sale of NFT using cryptocurrencies as there are no capital gains taxes in Singapore.
So, should you ever consider moving abroad to a low-tax country, or heck even a tax-free country to maximize your money, please reach out to us as this is what we specialize in: helping people move somewhere where their financial situation is optimized.
Conclusion – NFT Tax
In the US When you sell NFTs, it Is considered a disposal of assets held for investment purposes, so the transaction will generate capital gain or loss.
If it is short-term capital gain, it is taxed at your marginal ordinary income tax rate. If it is a long-term capital gain, the gain may be subject to a higher 28% maximum rate.
In the UK if an NFT is bought as an investment and subsequently sold, any gain realized following conversion of the purchase and sale prices into the Pound/Sterling exchange rate (on the relevant dates of sale and purchase) will be subject to Capital Gains Tax. The same thing is true in Canada.
However, keep in mind that if you’re in the business of creating and selling an NFT taxes work exactly like creating and selling anything else, and therefore this income qualifies as business income.
If you were a store owner selling widgets, you’d pay taxes on the income from those sales (either self-employment taxes or business taxes if you’ve formed an entity), minus any applicable business expenses.
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NOTICE: The content of this article is not to be considered as a legal opinion or tax advice. Wanderers Wealth does not hold itself out as a legal or tax advisor. If you want to receive a legal opinion or tax advice on the matter in this article please contact us directly and we will refer you to a legal practitioner.