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Taxation of Non Fungible Tokens

Nonfungible Tokens (NFTs) have gained immense popularity in recent years as unique digital assets that can be used to certify ownership and authenticity of associated rights or assets. However, the tax treatment of NFTs remains uncertain, which has raised concerns for taxpayers, tax professionals, and investors. This article aims to provide an overview of the IRS’s request for feedback and the current tax treatment of collectibles.

The IRS Requests Feedback on the Tax Treatment of Nonfungible Tokens (NFTs) as Collectibles

The Treasury Department and the Internal Revenue Service (IRS) have recently issued Notice 2023-27, in which they are seeking public feedback on upcoming guidance regarding the tax treatment of Nonfungible Tokens (NFTs) as collectibles under the tax law. The IRS also requests comments on the treatment of NFTs as collectibles and describes how they will determine whether an NFT is a collectible until further guidance is issued.

What are Nonfungible Tokens (NFTs)?

NFTs are unique digital identifiers recorded using distributed ledger technology such as blockchain technology. They can be used to certify the authenticity and ownership of associated rights or assets. A token is a unit of data encoded on a distributed ledger, which can identify ownership of NFTs and fungible tokens, such as cryptocurrencies.

What is the tax treatment of Nonfungible Tokens (NFTs)?

The current tax treatment of NFTs is unclear, but Section 408(m)(2) of the tax code provides guidance on the tax treatment of collectibles for certain purposes, which includes NFTs. If an IRA or an individually directed account of a qualified plan acquires an NFT that is classified as a collectible, it is treated as a distribution from the account equal to the cost of the NFT. Collectibles, including NFTs, do not typically receive as advantageous capital gains tax treatment as other capital assets.

How will the IRS determine if an NFT is a collectible?

Until additional guidance is issued, the IRS will use a “look-through analysis” to determine whether an NFT is a collectible. The “look-through analysis” is a method used by the IRS to determine whether an NFT should be classified as a collectible for tax purposes. This analysis involves examining the associated right or asset of the NFT and comparing it to the definition of collectibles in the tax code. If the associated right or asset falls under the definition of collectibles, the NFT will be treated as a collectible.

For instance, if an NFT certifies ownership of a gem, it would be classified as a collectible since a gem is a collectible under Section 408(m) of the tax code. The same logic would apply to other assets such as artwork or antiques, which are also considered collectibles under the tax code.

The IRS’s request for feedback on the tax treatment of NFTs as collectibles is a significant development for taxpayers, tax professionals, and investors. With the increasing popularity of NFTs, it is essential to have clarity on their tax treatment to avoid any potential tax liabilities or penalties. The IRS’s look-through analysis for determining whether an NFT is a collectible until further guidance is issued provides some guidance, but the input from stakeholders is crucial in shaping the future of the tax treatment of NFTs. Therefore, taxpayers, tax professionals, and other interested parties should provide their feedback to the Treasury Department and the IRS to ensure a fair and efficient tax treatment of NFTs as collectibles.

Article by Muhammad Junaid, Senior Tax Manager

Matthew John McNally
Matthew is an enrolled agent with two decades of tax planning, compliance, and advisory experience, much of it at Big Four accounting firms, where he guided clients with wide-reaching financial concerns.