Yesterday I posted an article about tax considerations involving NFTs. Specifically, how Bob, the theoretical character, incurred additional tax liabilities via NFT flipping. Today, I’ll discuss one scenario for how the NFT could be impacted by US tax treatment.
First, let's set some groundwork.
- Short-term capital gains tax is a tax on profits from the sale of an asset held for one year or less. Your tax rate is based on your ordinary income tax rate.
- Long-term capital gains tax is a tax on profits from the sale of an asset held for more than one year. Your long-term capital gains rate is 0%, 15%, or 20%, depending on your taxable income and filing status.
The IRS defines Bitcoin and Ethereum as property.
Assets held for more than one year are taxed as property incurring capital gains of 0%, 15%, or 20%. This tax treatment incentivizes “hodlers” (jargon for individuals who are long cryptocurrencies) to maintain their assets. The incentive is helpful to the overall ecosystem as it prevents people from dumping assets prematurely.
The IRS is likely to tax Crypto Traders and NFT Collectors differently.
Although there are no specific rulings by the IRS, they are likely to determine the tax rate based on the underlying asset. Subsequently, NFTs for works of art fall under the category of "collectibles," which incur long-term capital gains of 28% (in the US).
And Twitter may make it hard to argue otherwise.
Most of the NFTs you see posted on Twitter, such as Bored Apes, Mutant Apes, Rocks, etc., are marketed as “works of art.” From a technology perspective, they could also have fallen under the category of property assets such as Bitcoin and Ethereum.
However, since the Twitter consensus has broadly defined such NFTs as “works of art,” the IRS will likely follow this line of thinking. And it would be hard to argue otherwise with so much content out there favoring them as such.
When “hodlers” of NFTs for collectibles begin to do tax planning, many will realize there is no tax incentive to hold such assets for the long term given the 28% treatment.
I am concerned this will trigger massive sales on the market.
Many will sell at a loss. And when these sales happen, the value for NFTs will deflate. Ultimately, panic sales will flood the market shifting prices even further downward. One should not expect the NFT for works of art to be immune to the law of supply and demand.
NFTs have massive innovation potential.
Such innovations give hope to the ability to better society. However, the way NFTs are being used today potentially harms the ecosystem. Specifically, the ecosystem is harmed when people have a bad experience with new technologies.
But NFT flipping could harm the ecosystem.
If masses of people lose money on speculative "works of art," the term NFT will effectively become analogous to a virus that creates an allergic reaction within the market.
This allergic reaction could trigger companies that desperately need this technology not to adopt it for fear of reputational harm or losses. Subsequently, the technology does not gain traction, which it needs to attract true mass adoption.
Thanks for reading!
All the best,
Roy Naquin
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