The Carmel Arts District attracts visitors from near and far. The Palladium, eateries, boutiques, and art dealers all call the area home. When it comes to art and music, creators can now tokenize their creations with non-fungible tokens (NFTs). At Edgewater CPA Group, we know crypto, NFTs, and taxation can be confusing. Fortunately, we offer expert advice to everyone from art dealers and purchasers to business owners and investors.
What Are NFTs?
NFTs are unique digital items on a blockchain that associate with a specific file. For instance, digital images, music, and video files can all be assigned as NFTs. Unlike other cryptocurrencies, NFTs are unique (non-fungible), which means you can’t exchange them at a one:one ratio. Whereas one Bitcoin can be traded equally for another Bitcoin because they have the same value, NFTs cannot. Interestingly, while you can reproduce an NFT’s base file, you can’t reproduce the metadata and unique ID created by the NFT.
Are NFT Transactions Taxed?
Again, NFTs are unique digital items, which you typically purchase with other cryptocurrencies. Thus, the IRS views the transactions as taxable trades. Let’s look at an example:
In April, you purchase 3 ETH at $500 each for a total of $1,500. In July, the ETH value rises to $1,000 each. You purchase an NFT for $2,000 ETH during July, which takes two of your three ETH. Then, you sell your NFT in September for 2 ETH, which values at $1,200 each at the time, for a total of $2,400.
In the scenario above, you experience two taxable events. First, the July purchase of the NFT required you to cash out your ETH for a gain of $1,000. This would be taxed as capital gains. Second, the sale of your NFT in September for $2,400 resulted in a gain of $900 because the original purchase price was $1,500. Therefore, that transaction is also taxable as capital gains.
Are All NFTs Taxed as Capital Gains?
Mostly, but not all the time. Because NFTs represent things like music and art, some are considered collectibles. Some collectibles incur higher capital gains tax rates. For art dealers, NFTs are considered inventory. Therefore, purchases and sales are treated as income.
How Do I Report NFT Purchases and Sales?
Like most other investments, NFT purchases and sales don’t become taxable until they are sold at a higher value than purchased. Thus, you report the transaction when you file taxes for the year it was sold if you turned a profit. If you purchase and sell an NFT in the same year for a profit, the gain is taxed at the short-term capital gains tax rate.
Professional Cryptocurrency Accounting
Crypto, NFTs, and taxation can be complicated, but Edgewater CPA is here to help. If you deal with NFTs and cryptocurrency in Carmel, Indianapolis, or beyond, schedule a consultation with us. We also provide other professional financial services, such as bookkeeping and payroll services. Call today at (888) 317-4835 to learn more.