The U.S. Internal Revenue Service is attempting to clarify how the murky area of non-fungible tokens (NFTs) should be classified for tax purposes.
Yesterday (March 21), the IRS and the U.S. Treasury Department announced they were soliciting feedback on upcoming guidance regarding their classification of NFTs as collectibles for tax purposes, a category which includes assets like physical artwork, antiquities, coins and gems.
This classification is likely to raise taxes on NFT profits, in addition to excluding the digital assets from individual retirement accounts.
“This is potentially pretty significant,” said Andrew Gordon, an Illinois-based tax attorney specializing in cryptocurrency and NFTs. While the digital assets have gained popularity in recent years, there wasn’t any formal guidance on how they should be classified for tax purpose, he said. “From a tax standpoint, there’s been ambiguity on whether they’d be taxed as collectibles or taxed the same as cryptocurrencies.”
In October, the IRS introduced a draft bill grouping NFTs and cryptocurrencies under the same “digital assets section,” leading some to believe NFTs wouldn’t become collectibles, said Gordon. Now, the agency’s announcement appears to clarify they will likely be grouped as collectibles in the future, with financial implications for NFT holders.
An increase in capital gains tax
“Generally, collectibles also do not have as advantageous capital-gains tax treatment as other capital assets,” the IRS said in its announcement. Under the U.S. tax code, once they are sold collectibles are subject to a capital gains tax rate of 28 percent, compared to the rate of 20 percent for stocks, bonds and cryptocurrencies, said Gordon. Collectibles are additionally prohibited from being held in IRAs.
The IRS said it plans to determine NFT classifications on a case-by-case basis and will determine groupings by examining associated rights and assets. For example, an NFT associated with a gem will fall under the collectible category, while an NFT associated with the development of a virtual plot of land in the metaverse could be classified as a non-collectible asset.
This will cause extra work for NFT holders and tax professionals, according to Gordon. “It would make things simpler if there was an overall classification.”
The IRS and Treasury Department are requesting comments on the new proposal, including what burdens it will impose and how an NFT should be classified when it has multiple rights associated with both collectibles and non-collective assets, which they will be accepting and making public until June 19.
“Part of the uncertainty right now is will this guidance from the IRS be on a going-forward basis, or will it be retroactive?” said Gordon, who hopes the agency chooses the former option. Otherwise, those who held or sold an NFT in the past may end up owing taxes from years prior due to the difference in the capital gains tax rate, he said.