Tax Treatment of NFTs as Collectibles
Non-fungible tokens (NFTs) have been making headlines in recent years as a new form of digital asset that can be bought, sold, and traded. Similarly to many types of digital assets, the tax treatment of NFTs has been ambiguous. In March 2023, the Internal Revenue Service (IRS) issued Notice 2023-27 to provide guidance on how NFTs may be considered for tax purposes. While the notice avoids bright line tests and assertions, it provides some clues as to how the IRS may look at these transactions.
The notice establishes a new term, “digital file.” The notice suggests that a “digital file” has an associated right or asset. A “digital file” is understood to be unique from a “digital asset,” which was recently defined and codified in Section 6045. The notice suggests that certain NFTs may be treated as collectibles under section 408(m) of the Internal Revenue Code. This means that if you sell an NFT which meets the definition of a collectible under section 408(m) for a profit after holding it for more than one year, you may be subject to a 28% collectibles tax rate as opposed to the top long-term capital gain tax rate of 20%.
The IRS intends to determine whether an NFT constitutes a section 408(m) collectible by analyzing whether the NFT’s associated right or asset is a section 408(m) collectible. This is referred to as the “look-through analysis.” For example, if an NFT certifies ownership of a gem, which is a section 408(m) collectible under section 408(m)(2)(C), then the NFT would also be considered a section 408(m) collectible.
However, if an NFT’s associated right or asset is not a section 408(m) collectible, then the NFT would not be considered a section 408(m) collectible. For example, if an NFT certifies ownership of a digital artwork that does not meet the definition of a collectible under section 408(m), then the NFT would not be considered a collectible.
In conclusion, Notice 2023-27 provides much-needed guidance on how non-fungible tokens may be treated for tax purposes. The IRS is currently seeking comments on the proposed treatment. Taxpayers who own or trade in these digital assets should consult with their tax advisors to ensure they report their transactions correctly and take advantage of any available tax benefits.