The NFT market has ballooned to $44 billion, Chainalysis data shows, and the rules for taxing tokens are unclear.
It’s one of the hottest corners of cryptocurrency – and now the US government wants its share of the profits.
Investors and creators of non-fungible tokens — a market that has swelled to $44 billion and attracted fans from Justin Bieber to Melania Trump — are facing billions of dollars in taxes and rates as high as 37%, according to tax experts. Internal Revenue Service officials dealing with tax evaders say they are preparing for a crackdown.
The surprises looming for NFT fans when tax filing season begins this month is the latest wake-up call from Washington, as officials across the US government set their sights on the booming industry. The rules about taxation of tokens are unclear, leaving NFT collectors scrambling to calculate how much they owe. Investors may not realize that they need to pay any taxes at all or that they must file more than once a year, which increases their odds of facing future penalties.
“You cannot report gains or losses because the IRS has failed to provide guidance that meets your expectations,” said San Francisco-based tax attorney James Kreich. “The more difficult it is for people to arrive at a reasonable – or ideally, correct – conclusion, the easier it is to ignore it.”
NFTs have gained attention as representations of digital art and are expected to be a major part of the so-called metaverse that tech giants like Mark Zuckerberg say is the future of the internet. Tokens are digital certificates of authentication and cannot be copied, which likely increases their value.
Token sales have skyrocketed in the past year, with NFTs like CryptoPunk #3100 – which features an alien wearing a headband – selling for $7.7 million after an initial price of $2,000 in mid-2017. “Everyday: the First 5000 Days” sold out. Digital artist Mike Winkelman, aka Beeple, for $69.3 million.
Like much in the crypto world, tokens are hard to compare to traditional investments, and regulators, including those at the IRS, are wrestling with how to monitor them.
When a creator sells an NFT on a platform like OpenSea or Rarible, most tax experts agree that earnings should be considered ordinary income and subject to a high rate of 37%. Investors who buy tokens owe capital gains taxes if they use another currency to buy, and when they sell it.
Beyond that, the rules are vague. There are questions about whether tokens such as “art collectibles,” which come with a long-term capital gains rate of 28%, should be taxed. This compares to 20% for most cryptocurrencies and stocks. An infrastructure bill signed by President Joe Biden last year would make it more difficult for people to hide digital assets, but the Treasury has not said whether that includes NFTs.
It’s hard to calculate exactly how much tax is due, but experts like Arthur Teller, chief operating officer of TokenTax, estimate the total NFT tax bill could run into the billions. TokenTax co-founder Zac McClure said some people don’t realize they owe taxes every quarter and may actually face penalties just for filing an annual return. Other people likely don’t know that there are any reporting requirements, said Sheehan Chandrasekera, head of tax strategy at CoinTracker.
With so much money at stake, the IRS will likely have to clarify the rules, but it may start scrutinizing people first, said Michael Desmond, a former IRS senior adviser who is now a partner at Gibson, Dunn & Crutcher.
IRS investigators are preparing for a possible increase in cases as soon as this year.
“Later we will likely see a potential influx of NFT-type tax evasion, or other tax evasion cases on crypto assets,” said Jarrod Koopman, Acting Executive Director of Electronic Services and Forensics in the IRS Criminal Investigation Division.
In the meantime, NFT aficionados should prepare for more paperwork.
“It’s an absolute nightmare,” said Adam Hollander, an NFT investor and founder of the “Hungry Wolves” group, adding that he spent 50 hours combing through months of transactions. “There are people who will not be willing to do what I do.”
Assisted by Beth Williams.