The IRS gives guidance on virtual currency, however tax treatment of non-fungible tokens (NFTs) specifically has not been addressed. NFTs are considered to have a complete life cycle. It’s life cycle includes its creation, use, sale or exchange, contribution to a charity and total loss of value. How should tax professionals treat the gains, losses or income generated from NFTs?
It is likely that NFTs will be treated as collectibles since they typically contain original works of art. Their taxable treatment will be determined on whether you are the creator of the NFT selling them in the marketplace, or if you are an investor of NFTs and you are buying and selling them. If the NFT is sold, the original owner is entitled to collect payments or receive a portion of the sales proceeds as this would be taxable income for the original owner and new owner.
Regarding NFTs and its use of the word “token”, it is considered to be an intangible asset. A purchaser using the NFT in a trade or business may be able to amortize the adjusted basis of the NFT over 15 years using the straight-line method. Any potential losses from amortization deductions would be allowed assuming the you meet all of the loss limitation rules.
Due to the nature of NFTs, they are likely to be considered noncapital assets by creators, but capital assets to other owners other than the original creator. When the creator sells or exchange an NFT, the gains or losses are treated ordinary. Gains and losses on the sale of exchange of NFTs held by owners other than creators, results in a capital gain or loss.
The contribution of an NFT to a qualified charitable organization gives rise to a charitable deduction. What is the deductible amount? With intangible assets, a taxpayer may deduct the fair market value of item in certain situations.
If the NFT becomes worthless by an owner who purchased it for personal reasons, there is no allowable deduction for the loss. For trade or business use, the taxpayer should be able to take a deduction for the worthless asset.
NFTs are becoming more well-known and popular. It’s important that the IRS consider providing more guidance to taxpayers and tax professionals as there is so much to grasp here and tax consequences to prepare for. Do you have any additional non-fungible tokens questions? Feel free to contact a professional at Henry+Horne.