Kill NFTs and Cryptos? The IRS may tax them differently

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A woman watches an NFT titled “CURIO CARDS (EST. 2017)” on September 28, 2021, at the Christie’s auction house in New York City.

TIMOTHEE A. CLARY | AFP | Getty Images

In the digital world, not all taxes are necessarily equal.

Amid a boom in cryptocurrencies and non-fungible tokens (NFTs), wealthy owners may pay a different tax rate on the growth of investments in those holdings.

Specifically, an investor who sells DTV, such as digital art, may owe a federal tax rate of 31.8% on any income. By comparison, the appreciation of bitcoin, ethereum, and other digital coins is subject to a maximum rate of 23.8%.

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This is because DFTs are probably collectibles, for tax purposes. Collectibles are subject to a higher maximum capital gains tax rate compared to assets such as stocks, bonds, and cryptocurrencies.

The IRS has not explicitly said that NFTs are collectibles, leaving some room for interpretation. But many tax experts believe they clearly belong to the same group as art, antiques, gems, metals, stamps, and coins – which the IRS has labeled as tangible collectibles subject to the higher tax rate.

“I don’t see how it’s not a collector’s item,” said Jeffrey Levine, a St. Louis-based certified financial planner and accountant with Buckingham Wealth Partners, NFT.

NFT, crypto boom

NFTs are essentially unique digital assets, which can extend beyond art to things like tweets and GIFs.

The NFT market has grown rapidly. Sales reached $ 6 billion in the third quarter of 2021, up from around $ 22 million the year before, according to NonFungible.com. In March, Christie’s became the first major action house to sell NFT-based virtual artwork; the coin sold for $ 69 million.

Is it a collector’s item? It is not yet well settled because it is still a whole new area.

Troy lewis

Associate Professor of Accounting and Taxation at Brigham Young University

The number of TVN buyers has also increased – to around 260,000 in the third quarter of last year, up from 19,000 in the same period of 2020.

Likewise, a craze for crypto has gripped investors recently. More than 10% of U.S. adults own cryptocurrency, nearly two-thirds of which have purchased in the past year, according to a 2021 CNBC survey.

Capital gains tax

Investors pay capital gains tax when they sell an asset. The levy is due on any capital gain accumulated since the purchase.

The IRS typically taxes long-term capital gains at a higher federal rate of 20%. Long-term gains apply to cryptos and other assets held for more than a year.

In 2021, a single person with taxable income over $ 445,850 paid the maximum rate of 20%. (The less affluent pay a capital gains tax rate of 0% or 15%, depending on income.)

The wealthiest people also owe a 3.8% surtax on investment income, which amounts to over $ 200,000 in income for singles, for a total federal tax rate of 23.8% on capital gains.

However, collectibles – which tend to belong to the super-rich – are subject to a different tax regime.

Their long-term capital gains are taxed at a higher top federal rate of 28% and apply to different levels of income. The 3.8% surcharge also applies.

So a wealthy NFT owner could owe up to 31.8% federal capital gains taxes.

“If you have works of art or a classic car, for example, you [likely] a very wealthy person, which is why the IRS has this special long-term capital gains tax rate, ”said Shehan Chandrasekera, accountant and tax manager at CoinTracker.

How the tax works

Confusingly, different income thresholds apply to capital gains taxes for collectibles, according to Troy Lewis, associate professor of accounting and taxation at Brigham Young University.

Investors pay ordinary income tax rates on the appreciation of collectibles, up to a maximum of 28%. (There are seven marginal income tax rates – 10%, 12%, 22%, 24%, 32%, 35%, and 37% – that match income.)

“If your regular rates are below 28%, you pay your regular rates,” Lewis, who also owns an accounting firm in Draper, Utah, said of collectibles.

For example, a single taxpayer in the 22% tax bracket – which applied to income between about $ 41,000 and $ 86,000 last year – would pay a maximum rate of 22% on the appreciation at long term collectibles.

Conversely, a person in the 37% bracket – which applies to income over approximately $ 524,000 – would see their collection rate capped at 28%.

In both examples, the taxpayer would be liable for a higher tax rate on the appreciation of NFT than that of crypto.

Unstable

While the dominant view among tax practitioners appears to be that DFTs are collectibles, the case is not necessarily closed.

The IRS lists works of art and other “tangible personal property” as collectibles. NFTs probably fall under the “art” category, placing them in the category of collectibles; but DFTs are also intangible, which puts them in an obscure area of ​​tax law.

“Is it a collector’s item? Lewis said. “It’s not well settled yet because it’s still a whole new neighborhood.”

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