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How are NFTs taxed?

At the moment, anywhere from 15,000 to 50,000 NFTs are sold each week. These digital assets are only increasing in popularity so that number is expected to grow in the coming years. 

If you're interested in buying, trading, or selling NFTs, you need to understand how these non-fungible tokens are taxed. Read on to avoid unexpected tax bills and have a handle on the NFT game. 

How does the IRS classify NFTs?

Currently, the IRS has no official tax protocol for NFTs. However, NFTs may be treated in one of two ways:

  • taxed as property
  • taxed as collectibles

Since NFTs are associated with cryptocurrency, it is possible that they are taxed in much the same way. In this case, NFTs are considered property and will incur a short-term or long-term capital gains tax. Depending on your income, the long-term capital gains rate could be anywhere from 0%-20%, while the short-term capital gains rate is the same as your highest marginal federal tax rate.

A more accurate definition for NFTs may be as collectibles. This definition allows NFTs to be treated the same way as trading cards, antiques, rare comics, or traditional art. Collectibles held for over a year are taxed at 28%.

Since NFTs are commonly a form of digital art, this definition is more than likely to be used for tax purposes. However, it's best to talk with a financial expert about any tax questions you might have about NFTs before drawing any conclusions. 

How NFTs Can Impact Investors

Besides being taxed as either property or collectibles, NFTs can impact investors in numerous ways. Usually, this is through trading or selling. 

As an investor, you might choose to sell an NFT. Just like any other sale, you control if it becomes a capital gain or capital loss. For example, you buy an NFT at $5,000 of ETH (Ether) and sell it for $10,000 of ETH. You've just realized a $5,000 gain, so you might owe the taxman money on that capital gain come time to file your taxes.

Moreover, NFTs can be traded for other NFTs and incur capital gains or losses in much the same way. 

Using the same example, let's say you bought an NFT for $5,000 of ETH. You decide to trade it for another non-fungible token worth $3,000 of ETH. Now, you've just realized a tax loss of $2,000. This is another situation where you ultimately decide if you recognize a capital gain or loss.

One last thing to consider as an investor is how your capital gains tax rate can change depending on how long you own your NFTs. Like any other owned property, you might incur a short-term (held for one year or less) or long-term (held for over one year) capital gains tax rate. 

All of these scenarios are important to consider before tax season. Make sure to discuss them even more with your financial advisor.

Contact an Expert for Tax Help

NFTs are relatively new and are still confusing to many investors. Hopefully, this short guide gives you an idea of what to expect when navigating the world of cryptocurrency. 

It's normal to have more questions, and Mercer Street Personal Financial Services is here to help. If you need any more guidance, don't hesitate to contact us. Our team is here to help you get a handle on NFTs so you can start investing!

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