The IRS issues NFT tax guidance

Dive card:

• The Internal Revenue Service is seeking comment on the tax treatment of non-fungible tokens as a collectible under the tax code, the agency said in a release Tuesday.
• The request for comment, which defines an NFT as “a unique digital identifier that is recorded using distributed ledger technology and can be used to verify the authenticity and ownership of an associated right or asset,” seeks to determine the treatment of NFTs as collectibles , the IRS also provides guidance on how they will determine whether an NFT counts as a collectible in the meantime.
• Until further guidance is issued, the IRS will do so via “review analysis,” they said. The IRS relies on section 408(m) of the Internal Revenue Code for that analysis and to distinguish which NFTs are collectibles, which “provides that the acquisition of a collectible from an individual retirement account (IRA) shall be treated as a distribution from the IRA equal to the cost of the IRA for the collectible.”

Diving Insights:

Collectibles defined under section 408(m) include, among other categories, “any work of art, any rug, or antique” and “all metals or precious stones.” The section also states that “certain coins and bullion are excluded from the definition of collectible.”

For the purposes of this guidance from the IRS, this means that “an NFT is treated as a collectible if the NFT’s associated right or asset falls within the definition of collectible in the tax code,” they said Tuesday.

“For example, a gemstone is a collectible under section 408(m); therefore, an NFT certifying ownership of a gemstone is a collector’s item,” they said.

NFTs occupy a unique niche in the digital asset space both as part of and apart from the cryptocurrency space, as they usually signal ownership of another asset – for example a digital image, digital artwork, digital music, but they can also be linked to physical objects such as paintings. This sets a clear line between NFTs and cryptocurrencies; cryptocurrencies such as bitcoin are “fungible” or fungible in terms of value, while this is not the case for NFTs, according to a January report from Investopedia.

The dividing line between NFTs and other digital assets on the blockchain such as cryptocurrencies may be one of the reasons behind the former’s spike in trading at the start of the year, with total NFT trading volume up 38% month-on-month in January, according to a Tuesday report by Entrepreneur .

However, the agencies’ call for comments and updated guidance on NFTs follows a series of actions taken by regulators and lawmakers to address risk and uncertainty in the broader cryptocurrency market, following the large-scale collapse of crypto exchange FTX and other subsequent hiccups in the space.

Regulatory scrutiny of the cryptocurrency industry — including how it should be regulated and what status certain assets in the industry should have under tax law, such as stablecoins — had increased even before the exchange’s failure, with U.S. regulators playing tug-of-war over crypto standards and jurisdiction.

US Securities and Exchange Commission Chairman Gary Gensler noted in September 2022—three months before FTX’s collapse that November—during prepared remarks that the “vast majority” of crypto-tokens meet the definition of a security and thus are both covered by securities laws and the subject. to the SEC’s authority. After the FTX crisis, the SEC resumed its focus on crypto, asking companies to fully disclose the risks of cryptoassets and prompting the agency to shine a deeper spotlight on the risks facing public companies dealing with the industry as they and other regulators came under fire from legislators.

The closer examination of cryptocurrency standards has already led to further rumblings in the industry. Paxos Trust, the issuer of Binance-backed stablecoin BUSD, recently received a notice from the New York State Department of Financial Services to terminate its relationship with Binance, as well as a Wells notice from the SEC that alleged it was “considering recommending an action alleging that BUSD is a security,” CFO Dive previously reported. A Wells Notice is a formal notice from the SEC that tells the recipient of the agency’s intention to take enforcement action against them, according to Investopedia.

The cryptocurrency world has also faced layoffs on a large scale since the spring of 2022, with more than 26,000 jobs in the market lost by the end of the year and the 2023 figure reaching 1,900 at the end of January.

The uncertainty surrounding crypto and the market turbulence makes it all the more important that there is regulatory clarity and coherence. Jeremy Fox-Geen, CFO of stablecoin issuer Circle, noted that his company has always favored “a robust dialogue” with regulators, he said in an earlier interview.

“We have always believed that constructive relationships with regulators are critical, and the events of the past year have shown exactly why that is true,” he previously told CFO Dive.