The world has been overtaken by non-fungible tokens or NFTs, particularly in the art and music worlds. Collectors throughout the US are grappling with the US tax treatment of gains from the sales of NFTs. The key issue is whether NFTs are "collectibles" for US tax purposes in the hands of collectors, with long term gains taxed at higher rates than other long term capital gains.
Section 1(h)(4) of the Internal Revenue Code of 1986, as amended, provides that gains from the sale or exchange of collectibles are taxed at a rate of 28% rather than the usual maximum rate of 20%. Collectibles are defined under Section 408(m)(2) as follows:
- Any work of art,
- Any rug or antique,
- Any metal or gem,
- Any stamp or coin,
- Any alcoholic beverage, or
- Any other tangible personal property specified as a collectible by the IRS.
There are no regulations or other guidance issued by the IRS which further define the term "collectibles."
The issue of whether an NFT constitutes a "collectible" has been addressed in a number of articles in Forbes, CNN, Coindesk, TokenTax and elsewhere, with some articles concluding that NFTs constitute collectibles while others do not reach a firm conclusion.
NFT collectors take note
In our view, whether an NFT is a collectible turns entirely on rules of statutory construction and how one interprets the phrasing in item (f). Item (f) contains a reference to "any other tangible personal property", so the question becomes whether the reference to "any other tangible personal property" means that the property referred to in items (a) through (e) is also limited to "tangible" personal property. NFTs are clearly works of art, but they are also clearly intangible and not tangible personal property. If the reference in (f) limits the term collectibles to items that constitute tangible personal property, then NFTs would not constitute collectibles and would therefore be taxed at the lower, general long term capital gains rate. Note that in order to qualify for this lower 20% capital gains rate, in all cases the collector must have held the NFT for at least 12 months.
Regardless of whether NFTs are classified as collectibles, collectors should recall that, as with the gains from the sale of any capital asset, the gains from the sale of an NFT may additionally be subject to an additional 3.8% net investment tax and other state taxes.
Finally, we note that the determination of whether NFTs should be classified as collectibles may have farther reaching implications than the applicable tax rate. For instance, with some narrow exceptions, acquisitions of "collectibles" by individual retirement accounts (IRAs) or qualified retirement plans may be penalized and should generally be avoided.
NFTs and tax in the hands of the originating artist
As an aside, NFTs would not constitute a capital asset in the hands of the originating artist either because they are self-created artistic compositions or they are inventory under Section 1221(a)(1),(3). Thus in the hands of the artist, any gains from the sale of NFTs would constitute ordinary income which would be taxed at rates of up to 37% federal plus any applicable state taxes.
In recent months, U.S. lawmakers have turned their gaze to a variety of legal issues involving NFTs as well as tax reform generally. For this reason, in addition to other changes in the NFT regulatory landscape, collectors and artists should take note that the federal ordinary income rates, capital gains rates, and collectibles rates may be subject to increases in the coming days.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.