IRS Update: New Guidance and Request for Feedback on NFTs

The rise in popularity of non-fungible tokens (NFTs) in recent years has called into question how these tokens must be declared and taxed. Earlier this year, the IRS announced related changes for declarations of digital assets on Form 1040. Now the agency has issued preliminary guidance – as well as invited feedback – on more detailed treatment of these items for tax purposes.

But first things first. What IS an NFT? Very briefly, the term refers to a one-of-a-kind digital asset number that conveys ownership of digital content such as an image, video, and/or music.

The number is recorded in a format using distributed ledger technology, such as blockchain, which represents ownership in a digital-only but legal manner. As such, the item described by the NFT may be taxable, as with any asset recorded in a legal ledger. NFTs are distinct from fungible tokens (such as cryptocurrencies) that are themselves considered a taxable asset.

Currently, for tax purposes, the IRS uses a “look-through analysis” with regards to NFTs, and taxes each one according to the category of the item for which it indicates ownership. For instance, if the NFT refers to a collectible item, it is liable for increased capital gains rates associated with collectible items (defined by section 408[m] – typically art, antiques, gems, stamps, etc. but now also including some electronic artworks).

For 2023, the IRS is seeking feedback in two distinct areas related to the taxing of NFTs:

• Is the definition of NFT itself (provided above) accurate, or should it be revised?
• Is the taxation standard of NFTs (currently primarily divided into collectible vs. non-collectible, as described above) sufficient?

As more and more NFTs begin to refer to items that are completely digital in nature – for instance, digital artwork, digital files, or online-only possessions – the current IRS guidelines may require additional detail. Suggestions should be submitted in writing, referencing Notice 2023-27. These may be mailed in hard-copy form to the IRS directly at the address linked below, or by using the Federal eRulemaking Portal at www.regulations.gov.

As your trusted tax advisor, Weiss & Company LLP remains focused on providing our clients with the highest level of support in the tax filing process. Should you feel that the NFT tax issue affects your portfolio directly, we encourage you to reach out to your tax professional.