What NFT Creators Need to Know About Taxes | ASKramer law

The taxation of non-fungible tokens (NFT) remains something of a mystery. All we need to go by is the IRS definition of digital assets and Message 2023-27. The IRS definition of digital assets includes NFTs, which it says are a “digital representation of value recorded on a cryptographically secured digital ledger or similar technology.”[1] Notice 2023-27 suggests that certain NFTs are taxed as “collectibles”.[2]

Even without more government guidance, the tax treatment of NFT creators should be fairly straightforward.

People who create NFTs by registering tokens on a blockchain are often referred to as creators, and they include large corporations, artists, musicians, celebrities, influencers, athletes, sports fans, collectors, and writers. Sometimes creators make NFTs for fun, but NFTs give creators an opportunity to develop, market, and control the future of many types of digital content. Using blockchain also allows them to position their products for the future metaverse.

When a creator creates an NFT, it should not, under any tax principles, be a taxable event. The creation of an NFT does not arise from or represent the sale or exchange of property.[3] Analogous to the IRS analysis for convertible cryptocurrency set forth in Notice 2014-21, an NFT is likely to be taxed as property.[4] The creator should thus have a taxable event when an NFT is sold or exchanged for real currency, cryptocurrency, a digital token, another NFT or other property. (When a buyer pays for an NFT using property, rather than real currency such as US dollars, the transaction is taxed as an “exchange transaction.” As a result, the buyer, not just the seller, has a taxable event in the transaction.)

Determine whether an NFT is taxed as an ordinary asset or capital

Whether an NFT sale triggers ordinary or capital gain or loss depends on whether the NFT is an ordinary asset or an asset in the hands of the creator. There are two possible ways an NFT can be a common asset in the hands of its creator.

First, an NFT is likely to be an ordinary asset if the NFT is the result of the creator’s personal efforts or it is prepared or produced for the creator. An NFT is an ordinary asset if it is “a patent, invention, model, design (whether patented), a secret formula or process, a copyright, a literary, musical or artistic composition, a letter or memorandum or similar property.”[5]

The other way an NFT is likely to be treated as an ordinary asset is if it is part of the creator’s inventory, of some kind of property included in the inventory, or held for sale to customers in the ordinary course of the creator’s inventory. trade or business.[6] The easiest way for a creator to fall into this category is for the creator to be in the business of selling NFTs to customers.

Let’s look at the tax implications of NFT creators selling their NFTs to customers. A recent press release claimed a new “box office” for Super Tickets.™ Sports Illustrated Tickets has partnered with “Web3 leader ConsenSys” to sell such tickets for sports, music and theater events “powered by Polygon’s blockchain technology.”[7] The platform gives “owners, promoters and hosts the ability to create, manage and promote the sale of a wide range of tickets.”

Owners, promoters, and hosts of events that sell tickets in the form of NFTs to customers should receive ordinary income under Code §1221(a)(1). Moreover, the ordinary and necessary expenses paid or incurred by such owners, promoters and hosts in carrying on the trade or business of creating and selling tickets in the form of NFTs should be deductible.[8] These expenses will include the costs of creating NFTs, adding NFTs to a blockchain, and any expenses incurred for selling NFTs. The creator’s tax base will be determined on the basis of costs and expenses incurred when creating the NFT.[9]

What happens when creators sell or trade NFTs?

A creator realizes a gain or loss on the sale of an NFT. The size of the gain or loss is the difference between the value of the cash or property received and whether the tax sale amount is more or less than the taxpayer’s adjusted tax base in NFT.[10]

Rules for calculating gain or loss can be found in Code §1001 and the regulations issued under that section. As intangible assets, the tax basis of certain NFTs can be amortized, but it is not available to creators of NFTs.[11] Only NFT holders who have acquired those NFTs for sale or exchange in their trade or business may amortize their basis in the NFTs. This does not apply to creators of NFTs.

When the installment method or licensing and royalties apply

In an installment sale, the seller of the property receives at least one payment in a tax year after the sale takes place.[12] Reporting income on the installment method may be available to NFT creators who meet the requirements for installment reporting. These requirements are laid down in Code §453 and the regulations issued under this section. As an initial matter, the seller cannot be a dealer and the NFTs cannot be fixtures. Thus, the creator is not eligible for the installment method if the creator is a retailer or the NFTs are inventory.

Some or all of the copyright and intellectual property rights associated with an NFT are often retained by the creator. This means that an NFT’s metadata will include information about copyright ownership, license fees and the situations when and if any royalties are due. As a result, an NFT buyer only obtains the copyright or other intangible property if the rights were explicitly transferred to the buyer as part of the NFT buyers.

To encourage secondary market transactions, several NFT creators pass on some or all license and royalty payments to subsequent buyers. When the NFT creator receives royalties and license fees as additional income, these amounts are ordinary taxable income.[13]

[1]

[2] The IRS defines collectibles in Internal Revenue Code §408(m). Examples of collectibles include art, rugs, antiques, metals, gems, stamps, coins (with certain exceptions for gold, silver, and platinum coins), alcoholic beverages, musical instruments, historical artifacts, or other tangible personal property as defined by the IRS.

[3] Code §§61(a)(3), 1001.

[4] 2014-16 IRB 938.

[5] Code §1221(a)(3)(A).

[6] Code §1221(a)(1).

[7] “Sports Illustrated Tickets partners with ConsenSys to launch ‘Box Office,’ a brand new self-service event management platform and primary blockchain ticketing solution powered by Polygon” (2 May 2023).

[8] Code §162.

[9] Code §1221(a)(3)(C).

[10] Third. Reg. §1.61-(a).

[11] Code §197.

[12] Code §453(b).

[13] Code §1221(a)(3).

[View source.]