How are NFTs taxed? Understand the tax authorities’ new proposed guidelines

Example: Last week, the US Internal Revenue Service (IRS) published a document requesting comments and proposing new guidance on the tax treatment of NFTs. The statement, Notice 2023-27, questions whether NFTs should be classified in the same way as traditionally accepted collectibles such as stamps, physical works of art, and fine wine. It also leaves room for interpretation as to whether digital art can be included in the category of collectibles, or whether it needs a new category of its own.

Historically, IRC Section 408 includes only five categories of property categorized as collectibles: art, rugs or antiques, metals or gems, stamps or coins, and alcoholic beverages. Section 408 gives the IRS the authority to define new collectibles, but it specifically notes that these must be “tangible personal property.” Miles Fuller, head of government at crypto tax firm Tax Bit and former chief legal officer at the IRS, calls this difficulty a “legal rub.”

“The IRS can’t actually, at a regulatory level, say that they categorize all NFTs as collectibles because NFTs are not tangible,” Fuller explains.

Nonetheless, he considers Announcement 2023-27 a promising step toward increased clarity regarding the tax obligations of NFT collectors. Specifically, the IRS intends to treat NFTs as collectibles if they are associated with a physical item, an interpretation described in the document as a “look-through analysis.”

There are a few specific cases where this transparency analysis will already come in handy. For example, fractionalized NFT platform Otis sells NFTs tied to physical assets like rare books and trading cards, or companies like BlockBar, a Web3 company that focuses on NFTs tied to real-life rare wines and spirits. In these scenarios, an NFT can serve a similar purpose to a title or deed, Fuller explains. The tax authorities are not necessarily interested in taxing NFT as an asset in itself, when it is actually the token’s tie to a physical asset that makes it valuable.

“The IRS is not trying to tax the technology,” Fuller said. “It’s just trying to tax the economic unit that the technology gives rise to. The Tax Act is about taxing the actual financial property.”

The notice also appears to question whether the transparency analysis applies to digital art files themselves and whether digital art can be classified as a collectible in the same way as its physical counterparts. Justin Macari, a New York-based certified public accountant, predicts that the IRS will look closely at intellectual property rights (IP) when determining whether a digital asset has collective value. In the notice, the tax authorities list both topics in the list of requested feedback, and ask:

“I think it’s going to come down to IP usage,” Macari told CoinDesk. “I will be writing to the IRS to comment here because there is so much to say.”

Macari cited the example of Snoop Dogg, who owns Bored Ape #6723. Bored Ape owners have rights to the IP associated with their NFTs. As Macari argues, if owning NFT linked to a specific profile picture (PFP) or 1-of-1 NFT gives someone the right to create physical goods and profit-generating franchises, this could be a clear identifier of long-term collective value. In contrast, NFTs that simply represent digital assets, such as metaverse land, more closely resemble the IRS definition of normal capital assets and will be taxed accordingly.

Normal capital assets are taxed at a rate that varies from 0% to 20% based on a person’s income level, while collectibles are taxed at a rate of 28%. Despite the potential increase in the tax rate for NFT collectors, both Fuller and Macari believe the increased clarity is a net positive.

“I see this [notice] as a good thing because it gives more legitimacy to NFTs as a whole,” Macari said.

If you have thoughts on the matter, you can submit comments in writing on or before June 19, 2023. Be sure to include a reference to Notice 2023-27.

The easiest way to have your comment considered is electronically through the Federal eRulemaking Portal at www.regulations.gov (enter “Notice 2023-27” in the search bar on the Regulations.gov home page to find this notice and submit comments).