A tax shock threatens NFT buyers utilizing crypto

NFT non-fungible token art and collectibles illustration, use blockchain technology to create unique digital items for crypto art, crypto collectibles, and crypto games.

holly harry | iStock | Getty Images

According to tax experts, the craze for NFT can come with a painful tax surprise for buyers and sellers using cryptocurrencies.

According to NonFungible.com, sales of NFTs, or non-fungible tokens, have skyrocketed in the past few weeks, reaching over $ 500 million in 2021. Along with the sale of the $ 69 million Beeple NFT titled “Everydays: The First 5,000 Days” at Christie’s last week and the $ 3 million NFT sneakers, NFTs have NBA highlight videos up to to Jack Dorsey tweets created a huge new blockchain market-based digital assets to buy and sell.

However, experts say buyers and sellers are unlikely to know of any Internal Revenue Service tax rule to pursue – and cost it a large chunk of their profits. It involves a high potential tax for anyone who uses their highly valued cryptocurrency to purchase NFTs, which experts say is the majority of NFT sales.

“People know very little about this tax in the US,” said Shehan Chandrasekera, head of tax strategy at CoinTracker, a platform for tracking crypto portfolios and taxes. “I just don’t think people know about it.”

It’s about the latest IRS guidelines on using cryptocurrencies to purchase an asset, including an NFT. As part of its principle known as “Disposal of Assets”, the IRS states that “if you exchange any virtual currency held as an investment for any other property, including goods or any other virtual currency, a capital gain or – capture loss. “”

Chandrasekera said this has had a significant impact on the NFT craze, fueled primarily by collectors who use bitcoin or ether to buy NFTs. For example, if someone had bought a unit of ether for $ 100 in 2018, it would now be worth around $ 1,700. If they are using this unit of ether to purchase a $ 1,700 NFT, they may assume that they are not paying taxes on the ether because they are only using it to purchase a good or service.

“EVERYDAYS: THE FIRST 5000 DAYS” is a collage by digital artist BEEPLE that is being auctioned in Christie’s, an unknown location, in this undated Reuters flyer.

Christie’s Images LTD. 2021 / BEEP | via Reuters

However, under IRS rules, the ether is a net present value, not a currency. The owner would therefore be required to pay tax on the profit of $ 1,600 as part of the NFT purchase as the exchange for another asset is considered a sale or “disposition”. So, assuming a peak equity rate of return of 20%, you would owe the IRS a tax of $ 320. You might also owe state taxes since many states, such as New York and California, tax capital gains as income. (The rules for additional sales taxes in each state for NFTs are less clear.)

“You are not spending currency, you are spending an estimated asset,” said Chandrasekera. “So if you just spend it, it creates a chargeable event.”

If the NFT buyer later sells or “flips” the NFT at a higher price – which has become popular with NBA highlight videos and Beeple works – the seller would also pay a capital gains tax on any gain. And since NFTs are considered collectibles, they are taxed at the higher capital gains rate of 28%.

In other words, both buyers and sellers of NFTs are likely to face tax burdens that they did not consider when investing in NFTs.

Another problem is insufficient corporate reporting at the heart of the NFT boom. The major platforms that buy and sell NFTs, such as Flow by Dapper Labs or OpenSea, can report a sale, but they cannot report a buyer’s profit for the crypto used to make the purchase.

“They don’t know what a buyer originally paid for their Ethereum or Bitcoin, they can only report the selling price to the NFT,” said Chandrasekera.

Tax experts say it is almost impossible to know the total amount owed or not paid to the IRS from the NFT boom. Some say it’s on the order of tens of millions and maybe hundreds of millions.

Granted, NFT buyers who simply buy Bitcoin or Ether and immediately use it to purchase an NFT wouldn’t have to pay any tax. The tax only applies to those who buy NFTs with crypto that has increased in value since purchase.

In addition, the rules do not apply to foreign investors in NFTs. The buyer of the $ 69 million Beeple NFT, which was sold at Christie’s last week, for example, bears the pseudonym Metakovan and is based in Singapore. Tax experts say Metakovan would not have owed any tax on the estimated ether he used to purchase the piece because Singapore does not have capital gains tax. If he had been a US citizen, he could have owed more than $ 10 million in capital gains taxes on the purchase.

However, the IRS will get its share of the Beeple purchase. The artist who created and sold the work, Mike Winkelmann, who also comes from Beeple, owes federal and state income tax on the proceeds, as he is an artist by profession. According to experts, depending on the fees paid to Christie’s and MakersPlace, he could owe taxes in the tens of millions.

When Winkelmann learned that he could face such a significant tax burden, he told CNBC, “Holy sh– that’s a lot of taxes.”

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