The taxation of non-fungible tokens (NFTs) is still a bit of a mystery. All we have to do is go over the IRS definition of digital assets and the 2023-27 notices. NFTs are included in the IRS definition of digital assets, which states that they are “a digital representation of value recorded on a cryptographically secure digital ledger or any similar technology.” Notice 2023-27 states that certain NFTs are taxed as “collectibles”.
Even without any further government guidance, the tax treatment of NFT creators should be fairly straightforward.
People who create NFTs by recording tokens on the blockchain are often referred to as creators, and include major companies, artists, musicians, celebrities, influencers, athletes, sports fans, collectors, and authors. Sometimes creators create NFTs for fun, but NFTs offer creators the opportunity to control the development, market, and future of many types of digital content. Using blockchain also allows them to position their products for the metaverse of the future.
When a creator creates an NFT, it should not be a taxable event under any tax principle. The creation of an NFT does not represent or result in the sale or exchange of any asset. By analogy, under the IRS analysis for convertible cryptocurrencies set forth in Notice 2014-21, NFTs are likely to be taxed as property. Thus a taxable event must occur for the creator when the NFT is sold or exchanged for real currency, cryptocurrency, a digital token, another NFT, or any other asset. (When a buyer pays for an NFT using assets instead of actual currency, such as US dollars, the transaction is taxed as a “barter transaction”. As a result, the buyer, not just the seller, is taxed.) Qualifying event occurs. , Exchange.)
Determining whether an NFT is taxed as ordinary or capital property
Whether the sale of the NFT triggers an ordinary or capital gain or loss, regardless of whether the NFT is an ordinary or capital asset in the hands of the maker. There are two possible ways in which an NFT can be common property in the hands of its creator.
First, an NFT is likely to be common property if the NFT arises from the personal efforts of the creator or is designed or manufactured for the creator. An NFT is common property if it is “a patent, invention, model, design (whether patented or not), a secret formula or process, a copyright, a literary, musical or artistic creation, a letter or memorandum, or similar Property. “
Another way in which an NFT may be treated as ordinary property is if it is part of the maker’s stock in trade, is included in a type of property inventory, or is held for sale to customers in the maker’s ordinary course of action. She goes. Is. business or profession. The simplest way for a maker to fall into this category is if the maker is 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 describes a new “box office” for Super Ticket. ™ Sports Illustrated Tickets has partnered with “web3 leader ConsenSys” to sell such tickets for sporting, concert and theater events “powered by Polygon’s blockchain technology”. The platform “gives owners, organizers and hosts the ability to create, manage and promote the sale of a wide range of tickets.”
Owners, organizers and hosts of events that sell tickets as NFTs to customers must receive ordinary income under §1221(a)(1) of the Code. Further, ordinary and necessary expenses incurred or incurred by such owners, organizers and hosts in carrying on the business or trade of making and selling tickets in the form of NFTs shall be deductible. Those expenses would include the cost of creating the NFT, adding the NFT to the blockchain, and all expenses incurred for the sale of the NFT. The tax base of the manufacturer will be determined with reference to the cost and expenses incurred in making the NFT.
What happens when makers sell or exchange NFTs?
A maker realizes a gain or loss on the sale of the NFT. The amount of the gain or loss is the difference between the cash or value of the asset and whether the amount of the after-tax sale is greater or less than the taxpayer’s adjusted tax basis in the NFT.
The rules for computing the amount of gain or loss are contained in Code §1001 and the regulations issued under that section. As intangible assets, the tax basis of some NFTs can be amortized but this is not available to the creators of the NFTs. Only NFT holders who have acquired those NFTs for sale or exchange in their trade or business may amortize their basis in NFTs. This does not apply to creators of NFTs.
When installment method or licensing and royalties apply
In an installment sale, the seller of the property receives at least one payment in the tax year following the sale. Earnings reporting on the installment method may be available to NFT makers that meet installment reporting requirements. These requirements are set forth in Code §453 and the regulations issued under that section. As a preliminary matter, the seller cannot be a dealer and the NFT cannot be inventory. Thus, if the manufacturer is a dealer or holds NFT inventory, the manufacturer is not eligible for the installment method.
Some or all copyright and intellectual property rights associated with an NFT are often retained by the creator. This means that the NFT’s metadata will include information about copyright ownership, license fees, and when and whether any royalties are due. As a result, an NFT buyer only receives copyright or other intellectual property if the rights were expressly transferred to the buyer as part of the NFT purchase.
To encourage secondary market transactions, more NFT makers are transferring some or all of their license and royalty payments to subsequent buyers. When the NFT creator receives royalties and license fees as additional revenue, these amounts are ordinary taxable income.
 The IRS defines collectivity in Internal Revenue Code §408(m). Examples of collectibles include art, rugs, antiques, metals, gems, stamps, coins (with some exceptions for gold, silver, and platinum coins), alcoholic beverages, musical instruments, historical items, or other tangible items as defined by the IRS. Are included. Personal property is included.
 Code §§61(a)(3), 1001.
 2014-16 IRB 938.
 Code §1221(a)(3)(a).
 Code §1221(a)(1).
 “Sports Illustrated Tickets Partners with ConsenSys to Launch ‘Box Office’, an All-New Self-Service Event Management Platform and Primary Blockchain Ticketing Solution Powered by Polygon”(May 2, 2023).
 Code §162.
 Code §1221(a)(3)(c).
 Trace. Reg. §1.61-(a).
 Code §197.
 Code §453(b).
 Code §1221(a)(3).