The NFT market has grown to $44 billion, Chainalysis data shows, and the rules for taxing the tokens are not clear.
It’s one of crypto’s hottest corners – and now the US government wants its share of the profits.
Investors and creators of non-fungible tokens — a market that has grown to $44 billion, according to Chainalysis data and has attracted fans from Justin Bieber to Melania Trump — are facing billions of dollars in taxes and tax rates of up to , according to tax experts 37% faced. Internal Revenue Service officials who deal with tax evaders say they are preparing for a crackdown.
The surprises in store for NFT enthusiasts when tax filing season kicks off this month are crypto’s latest wake-up call from Washington as officials across the US government target the burgeoning industry. The rules for taxing tokens are not clear, so NFT collectors are trying to calculate how much they owe. Investors may not realize that they have to pay taxes at all, or that they should apply more than once a year, increasing the likelihood of facing penalties in the future.
“You cannot report gains or losses because the IRS failed to provide guidance that meets your expectations,” said San Francisco-based tax attorney James Creech. “The harder it is for people to come to a reasonable — or ideally correct — conclusion, the easier it is to ignore it.”
NFTs have garnered attention as representations of digital art and are expected to be an important part of the so-called metaverse that tech titans like Mark Zuckerberg are saying is the future of the internet. The tokens are digital certificates of authenticity and cannot be replicated, potentially increasing their value.
Token sales have skyrocketed over the past year, with NFTs like CryptoPunk #3100 — which features an alien with a headband — selling for $7.7 million after seeing an initial price of $2,000 in mid-2017. Everydays: the First 5000 Days by digital artist Mike Winkelmann, aka Beeple, has sold for a staggering $69.3 million.
As is often the case in the crypto universe, it’s difficult to compare tokens to more traditional investments, and regulators, including the IRS, are wrestling with how to monitor them.
When a creator sells an NFT on a platform like OpenSea or Rarible, most tax experts agree that the gains should be considered ordinary income and should be subject to a tax rate of up to 37%. Investors who buy the tokens will owe capital gains taxes if they used another cryptocurrency for the purchase and if they sell them.
Beyond that, the rules are murky. The question arises as to whether tokens should be taxed like art “collectibles” that come with a long-term capital return rate of up to 28%. That compares to 20% for most cryptocurrencies and stocks. The infrastructure bill that President Joe Biden signed into law last year will make it harder for people to hide digital assets, but the Treasury Department hasn’t said whether that includes NFTs.
It’s hard to calculate exactly how much tax is owed, but experts like Arthur Teller, Chief Operating Officer at TokenTax, estimate that the total NFT tax bill could be in the billions. Some people are unaware that they owe taxes quarterly and could already face penalties for just filing an annual tax return, said Zac McClure, co-founder of TokenTax. Other people probably don’t know there are reporting requirements, said Shehan Chandrasekera, head of tax strategy at CoinTracker.
With so much money at stake, the IRS will likely be forced to clarify the rules, but it might start checking people first, said Michael Desmond, the IRS’s former chief attorney and now a partner at Gibson, Dunn & Crutcher is.
IRS investigators are bracing for a possible spike in cases as early as this year.
“We will likely see an influx of potential NFT-type tax evasion or other crypto-asset tax evasion cases as a result,” said Jarod Koopman, acting executive director for cyber and forensic services at the IRS’s Criminal Investigations Division.
In the meantime, NFT fans should brace themselves for a lot more paperwork.
“It’s an absolute nightmare,” said Adam Hollander, an NFT investor and creator of the Hungry Wolves collection, adding that he spent 50 hours combing through months of transactions. “There are people who will not be willing to do what I do.”
–With support from Beth Williams.