Yes, you have to pay taxes on the sale of NFTs

A new tech term broke into the mainstream American lexicon in 2021: NFTs. An NFT, short for non-fungible token, is a unique certificate most often used as a receipt of ownership for a digital item like an image or a video. Celebrities and Times Square billboards have advertised these digital collectibles increasingly as NFTs have grown in popularity. 

One of the primary ways people use NFTs is as investments, hoping the value of the NFT will appreciate over time so they can sell it for a profit. One popular TikTok video warned that doing this will create two taxable events, and suggested that people who sell NFTs should set aside money for taxes.

THE QUESTION

Do you have to pay taxes if you sell an NFT?

THE SOURCES

• Internal Revenue Service (IRS)
• Merav Ozair, Ph.D., assistant professor of professional practice at Rutgers Business School
• Amy Miller, senior manager at the American Institute of Certified Public Accountants (AICPA) Tax Policy & Advocacy Team and specialist in cryptocurrency

THE ANSWER

Yes, you do have to pay taxes if you sell an NFT.

WHAT WE FOUND

Even though NFTs are strictly digital assets, they’re still taxed just like physical assets, according to tax and technology experts. 

“If you sell anything in the physical world, will you have to pay taxes?” said Merav Ozair, Ph.D., a financial tech expert at Rutgers University who specializes in cryptocurrency. “If I sell anything, I will have to record it on my tax report and pay taxes… So if in the physical world it makes sense to you, then why not in the digital world, right? It's an asset, like any asset, whether it's digital or it is physical, there's no difference.”

What’s an NFT?

An NFT is a non-fungible token. These unique certificates serve as receipts of ownership, often for digital files like digital art, videos, photos and audio files. They’re stored in a type of highly secured database called a blockchain. This technology is also the foundation of cryptocurrencies like Bitcoin.

But because each NFT is unique, it’s not intended to be used as a kind of currency like Bitcoin. Instead, NFTs are bought and sold as collectibles or investments, most of the time purchased with cryptocurrency.

“Something fungible is something that is interchangeable, like the dollar bill,” Ozair said. “When you go and buy coffee at Starbucks, it doesn’t matter, we know which dollar bill to give them, they’ll accept any. So that's fungible. Non-fungible is something that is unique, anything can be unique. Everything that is unique is what we call non-fungible.”

Are NFTs taxable?

While the Internal Revenue Service (IRS) has an official policy on cryptocurrency, it doesn’t yet have one for NFTs. The IRS says “virtual currency” is treated as property for federal income tax purposes. It defines such a transaction as involving the receipt or transfer of a virtual currency for free, an exchange of virtual currency for goods and services, and the sale of virtual currency or the exchange of virtual currency for other virtual currency or property.

Because both NFTs and cryptocurrency are treated as property by the IRS, anyone who buys an NFT in the first place will likely face a tax on the cryptocurrency they used to buy it, according to Amy Miller, senior manager at the American Institute of Certified Public Accountants (AICPA) Tax Policy & Advocacy Team and a specialist in cryptocurrency.

“That's because most NFTs you need to use some form of cryptocurrency, like Ethereum or Solana, to make the purchase of the NFT,” Miller said. “And because the IRS treats cryptocurrencies as property, it means trading crypto for an NFT could be a capital gain that's taxable. There was likely a fluctuation in the price of a cryptocurrency between the time you purchased that cryptocurrency with cash and the time you then traded that cryptocurrency for an NFT.”

So if you bought five cryptocurrency coins worth $100, and then you use those same five cryptocurrency coins to buy an NFT after they had risen in value to $150, you’ll be taxed for the $50 increase in value between the time you bought the coins and used them to buy an NFT.

This doesn’t apply to an NFT bought using U.S. dollars, but very few NFTs can be purchased without using cryptocurrency.

But you will always be taxed for selling an NFT, regardless of if you sold it for U.S. dollars or for cryptocurrency. How it’s taxed, however, will depend on if you create NFTs or just invest in them.

“If you're in the business of making NFTs, you’re in the business of selling art, you're in the business of mining virtual currency — that is taxed differently than if you're in the business of investing,” Miller said. 

If you buy and sell NFTs as an investor, she said, you will pay capital gains taxes. If you mint NFTs and sell them as their original creator, you’re taxed for the sales the same as you are for any other business income.

Currently, the IRS applies the capital gains tax to the sale of cryptocurrencies. The IRS says capital gains are split into two categories: short-term capital gains, which are assets a person flips for a profit within a year of buying it, and long-term capital gains, which are assets a person holds onto for longer than a year before selling it. Short-term capital gains are taxed at the same rate as an ordinary paycheck. Long-term capital gains are taxed at 15% for most people. 

“The IRS has a question at the top of the 1040 form asking if at any time during 2021 did you receive, sell, exchange or otherwise dispose of any financial interest in any virtual currency?” Miller said. “And taxpayers are required to answer yes or no to that question.”

So anyone who mints new NFTs and sells them would simply report their sales as income and would pay the same taxes on them as they would the rest of their income. Anyone who buys and sells NFTs as an investment will be taxed first when they exchange cryptocurrency for an NFT and then a second time when they sell the NFT. 

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