According to the IRS, it intends to tax some non-fungible tokens (NFTs) as collectibles with tax rates higher than those applied to assets like stocks, real estate, and cryptocurrencies. This strategy would tax wealthy owners’ profits more heavily.
Taxes on collectibles held for more than a year are assessed by the federal government, with the top rate being 28%. On other investments, it typically charges an upper 20% rate.
The IRS announced its intention to provide guidance regarding the classification of some NFTs as collectibles in a notice on Monday.
In essence, NFTs are unique digital assets, which can go beyond digital art to include things like tweets and GIFs. They occasionally also grant owners a right in relation to a non-digital asset, such as the ability to confirm ownership of a tangible object or attend an event that requires a ticket.
Public comments were requested by the IRS and are due by June 19.
Shehan Chandrasekera, an accountant and the head of tax strategy at CoinTracker, claimed that the IRS had not previously made any statements regarding NFTs. Because it has not yet been finalized, this is sort of like half guidance.
Taxation Of NFT By IRS – How Much Rich People Have To Pay(Photo: https://blog.gilded.finance/)
Taxation of NFTs by the IRS
In recent years, NFT enthusiasm has increased in tandem with the rise in popularity of cryptocurrencies like bitcoin.
.
That energy, though, has since peaked. According to NonFungible.com, NFT volume decreased 77%, to $1.7 billion, in the third quarter of 2022 compared to $7.4 billion in the second quarter. Additionally, there was a significant market decline in assets like stocks and bonds last year.
If an NFT is a collectible, the IRS will use a “look-through analysis” to make that determination.
In essence, it will determine whether the associated right or asset of the NFT is a collectible under the current definition of the tax code, and if so, whether the NFT itself is a collectible.
Chandrasekera asserted that “NFTs can represent anything, literally anything.” According to the IRS, taxation is dependent upon what it represents.
The federal tax code’s Section 408(m) defines a collectible as tangible personal property, which includes any type of artwork, rug, antique, metal, gem, stamp, coin, or alcoholic beverage.
The IRS stated that since a gem is a clearly defined collectible, an NFT that certifies ownership of a gem is also a collectible for tax purposes. This is an illustration of how the IRS would carry out a “look-through” analysis.
On the other hand, a “plot of land” in a virtual environment that has the right to be used or developed is typically not a collectible. The IRS stated that an NFT offering a right to use or develop that virtual plot also typically isn’t considered a collectible.
This look-through analysis will be used by the IRS until it releases NFT guidance in upcoming months.
According to Troy Lewis, an associate professor of accounting and tax at Brigham Young University, “This [guidance] comes right around tax filing deadlines.” You might want to consider this as Tax Day approaches.
The majority of Americans must file their federal taxes by April 18 this year.
“Clearly, the IRS signaled that this is how we view life until we give you something else,” Lewis continued.
How collectibles are taxed
When an investor sells an asset, they must pay capital gains tax. The seller’s profit is subject to tax.
Assets held for a year or less are subject to short-term capital gains. Ordinary income tax rates, such as those that are used to tax wages, are applied to the profit from those sales. The seven marginal tax rates have a range of 10% to 37%.
When an asset is sold after being owned for more than a year, long-term capital gains are applicable. These tax rates are generally lower than ordinary income tax rates.
A maximum rate of 20% is applied to stocks and cryptocurrencies for high-income taxpayers. Less wealthy people pay 0% or 15%.
Collectibles, on the other hand, are taxed differently and are frequently owned by the very wealthy. They pay up to 28% in taxes.
Additionally, their taxation is different: Collectibles are subject to ordinary income tax rates, which can reach 28%. This is distinct from the three-tier system for stocks (0%, 15%, and 20%).
Simply put, Americans with the highest incomes pay a higher tax rate on collectibles.
According to Lewis, taxpayers are generally not permitted to hold collectibles in tax-preferred individual retirement accounts.
That idea is supported by a recent IRS notice that says these retirement accounts cannot buy an NFT classified as a collectible without possibly incurring income taxes and penalties.
According to Lewis, who runs an accounting firm in Draper, Utah, the IRS guidance is “a serious advancement” for taxpayers and tax professionals.
It’s also inventive, in his opinion, in how it adapts the outdated tax code for tangible collectibles to a brand-new digital asset in the contemporary economy.
The idea of what constitutes a collectible is not always clear-cut, so there is still some gray area.
Lewis said of the IRS notice, “They don’t really deal with the hard issue, per se.” “What constitutes a collectible is still up for debate.”
Lewis gave the example of a rare car that someone keeps in their garage. The vehicle might be valued as a collectible by that person. Now imagine that a different person owns the same car but uses it to commute to work every day. Is the vehicle a mode of transportation or a collectible? What about a person who works at an antique desk on a daily basis?
It’s not entirely clear whether (or to what extent) a digital file qualifies as a “work of art,” the IRS noted in its NFT notice. The organization is looking for feedback on this issue as well as a number of others pertaining to NFT taxation.
Read also: Texas Senate Approves Property Tax Cut
