Among all blockchain projects, NFTs have been remarkable in their perpetual growth and adoption. As of May 2022, approximately $37 billion has been sent to NFT marketplaces by investors. This burgeoning niche has proven the blockchain industry to be a promising quasi-capital sector, hence the need for its financial niche to be taxed and in return an NFT tax guide to for creators and investors.
A tax is a charge or capital levy on a country’s citizens to support the government financially. Each government of every nation sets aside its tax agencies that oversee tax revenue by charging individuals and corporate organizations a certain percentage of their capital gain. This tax has also been extended to NFTs even when governments are still contemplating regulating the crypto industry.
Generally, the same rudiment of tax applies when a loss or gain is made. NFT taxes are based on capital gains.
What is Capital Gain Tax?
Capital gain tax applies to a profit made on a commodity, goods, or investment when they are sold or disposed of. For example, if you bought an iPhone for $500 and sold it for $600, you’ve gained $100. The profit you made is taxed, not the amount you received, i.e., the $100 profit is taxed, not the total $600. However, capital gain tax can be offset or reduced by capital loss.
What is a Capital Loss?
A capital loss occurs when you sell a commodity for a lesser amount it is worth or when you dispose of an investment for less than what you pay. A capital loss does not apply to personal use items like your car or house, but it applies to investments like cryptocurrency, stocks, mutual funds, real estate, and bonds. Capital loss can reduce capital gain tax by subtracting net loss from net gains.
The NFT tax is a charge levied on NFTs’ investors and enthusiasts whenever they buy or sell NFTs. Like another form of taxation, the NFT tax is also used to support the government through various percentages. In wake of this, creators, investors, and enthusiasts need to know the guidelines surrounding this new wave of taxes on NFTs.
What should they pay as investors, what is taxed and what is not. Please note that the guide below is a general NFT tax guide, and some rules are only applicable to the USA.
8 NFT Tax Rules for Investors and Creators
1. NFT creators are not liable to pay tax until you sell your NFT
As an NFT creator, you don’t owe any tax until you sell your NFTs. This is the same as producing a particular commodity; it is not taxed until you sell because no revenue is made on unsold items. When you sell your NFTs, the income generated will be regarded as ordinary income, taxed like any other income earned from work. However, if you create NFTs as a profession or business, you may also pay self-employment tax.
2. Minting NFTs may be taxable indirectly through gas fees
Ordinarily, creating or minting NFTs on the marketplace is not taxable, but in some rare cases, it might be taxable through a gas fee.
Assuming Jason –a hobbyist–mints a Mutant Ape NFT and spends 0.32 ETH for the gas fee, when he purchased the ETH about four weeks ago, it cost $176. When he mints his NFT, the 0.32 ETH value has increased to $300. So, minting his NFT with the same ETH will incur a capital gain of $124 ($300-$176), whereas the cost of minting his NFT is $300. Had it been that Jason minted as a professional creator, the $124 would have been his ordinary income.
3. NFT traders are not liable to pay tax until they make sales
Just like creators, NFT traders won’t also pay any tax until they’ve sold their NFTs. They can hold for as long as they wish and not pay tax, but if they sell for profit, they will pay tax at a particular percentage.
4. Purchasing NFTs may be taxable indirectly
If you’re buying NFTs with cryptocurrency, you’ll be taxed because IRS–Internal Revenue Service– categorized cryptocurrency transactions as taxable. For example, you’ll be taxed if you purchased ETH worth $1,800 and used it to buy NFTs worth $4,600. The reason for being taxed here is that the ETH you bought has been sold, and the proceeds are used to acquire NFTs. Your taxation will be measured whether your capital gain is long-term or short-term.
Long-term capital gain, in this case, is when you HODL your ETH for at least a year, while short-term is when you HODL your ETH for less than a year, taxed as the ordinary federal income tax rate.
5. Revenue made from the selling of NFTs or Royalties is taxed
When an investor or creator sells NFTs, the income is taxed depending on how long it is held–long-term or short-term. Some NFTs have royalties in their smart contract, which enables the creator to be entitled to a certain income anytime such NFTs are sold to another investor. Whenever the creator receives this royalty, it is also taxed because it is regarded as an income.
6. Royalties create a tax liability
When you receive royalties, you’re taxed in two ways; you’ll pay the ordinary income tax and self-employment tax on the value of each royalty you receive in crypto. This is because royalties are regarded as passive income anytime the NFT is re-sold.
7. Most NFT marketplaces won’t send you a tax form
Due to a lack of IRS guidance regarding tax reporting for digital assets, most NFT marketplaces won’t send you tax forms about your transactions. It suffices that you DYOR about your preferred marketplace for helpful information about taxation. Irrespective of this, it’s important to keep detailed records of your NFT transactions since you’re expected to report your transactions to IRS.
8. Donating NFTs is not taxable if donated directly to the charity
NFTs can be donated to charity homes, Museums or auctioned for charity’s sake. No tax is owed if the donor donated the NFT directly to a 501(c)(3) organization. But if the donor auctioned the NFT for charity first and donated the proceeds without transferring the NFT to the 501(c)(3), the donor will owe capital gains from the auction’s proceeds. However, the donor can be free from this by turning the auction’s proceeds into cash and making a large donation that can wipe off their tax liability to a charity organization.
501(c)(3) organizations are organizations exempted from the Federal income tax under section 501(c)(3) of Title 26 of the U.S. Code. Such organizations are usually non-profitable organizations like charity foundations and religious organizations.
NFT taxation extends beyond what’s discussed above; for example, NFT airdrops and exchanging one NFT for another is also taxable. However, the above information is not financial advice, as there are platforms that can help you to calculate your NFT taxes and provide information on allied matters.
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Technical writer, an enthusiast for everything blockchain and decentralized world.
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