IRS Sets Sights on Nonfungible Token (NFT) Investors

Investors and creators of nonfungible tokens (NFT), a market that has ballooned to $44 billion, face billions of dollars in taxes and federal tax rates as high as 37%. Internal Revenue Service officials who deal with tax evaders say they are gearing up for a crackdown.

Crypto’s latest wake-up call from Washington comes from the IRS who have set their sights on this burgeoning industry. The rules about taxing tokens aren’t clear, leaving NFT collectors scrambling to calculate how much they owe. Investors may not realize they need to pay any taxes at all or that they should file more than once a year, increasing the odds they’ll face future penalties.

NFTs gained attention as representations of digital art and are expected to be a key part of the so-called metaverse that tech titans like Mark Zuckerberg say is the future of the Internet. The tokens are digital certificates of authenticity and can’t be replicated, which potentially increases their value.

Token sales skyrocketed last year, with NFTs such as CryptoPunk #3100 — which features an alien sporting a headband — selling for $7.7 million after an initial price of $2,000 in mid-2017. “Everydays: the First 5000 Days” from digital artist Mike Winkelmann, also known as Beeple, sold for an eye-popping $69.3 million.

Like so much in the crypto universe, it’s hard to compare tokens to more traditional investments and regulators, including those at the IRS, are grappling over how to police them.

When a creator sells an NFT on a platform like OpenSea or Rarible, most tax experts agree that the profits should be considered ordinary income and be subject to a federal tax rate as high as 37%. Investors who buy the tokens owe capital-gains taxes if they used another cryptocurrency for the purchase, and when they sell it.

Beyond that, the rules are murky. There are questions about whether tokens should be taxed like art “collectibles,” which comes with a long-term capital-gains rate of up to 28%. That’s compared to 20% for most cryptocurrencies and stocks. The infrastructure bill President Joe Biden signed into law last year will make it harder for people to hide digital assets, but the Treasury Department has not said whether that includes NFTs.

With so much money at stake, the IRS will likely be forced to clarify the rules, but, in their infinite wisdom, they will probably begin auditing people first. IRS investigators are preparing for a possible surge in cases as soon as this year. In anticipation of an influx of potential NFT type tax evasion, or other crypto-asset tax evasion cases, the IRS has a dedicated department for cyber and forensic services within their criminal investigation division.

In the interim, NFT aficionados need to invest in both sophisticated accounting platforms to keep track of their transactions and accountants well versed in this space.

The information presented here should not be construed as legal, tax, accounting, or valuation advice. No one should act on such information without appropriate professional advice and after a thorough examination of the particular situation.