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NFTs: Not Free of Tax by JONATHAN KALINSKI

You can go on YouTube and watch the greatest dunks, home runs, touchdowns over and over and over and not pay a cent.  How much would you pay to “own” that highlight?  For many the answer is tens or hundreds of thousands.  NBA Top Shot is officially licensed by the NBA and in little time has become wildly successful selling non-fungible tokens, or NFTs.  Dapper Labs, the parent company, was recently valued at $2.6 billion.  The Golden State Warriors are the first team to formally launch an NFT collection.

The leader in the NFT market is the digital artist Beeple, real name Mike Winkelmann, who made headlines recently when he sold an NFT through Christie’s for $69 million.  Again, that same image can be yours for free.  Beeple has been a pioneer in selling NFTs, but many artists, musicians, and athletes are getting in on the action.  Tom Brady is apparently starting an NFT company.

What is an NFT?  For the uninitiated, it is a non-fungible token that lives in the blockchain.  Unlike bitcoin, it is unique.  No NFT is like another, and that is in part what gives it value.  There is a digital certificate that can be bought and sold, but the records stay on the blockchain.  This isn’t a blog on NFT basics, so are NFTs taxable?

The short answer is yes, but that doesn’t really tell you anything.  The specific tax consequences, like seemingly everything, depends.  If an artist creates an NFT and sells it the artist has a taxable sale.  The artist, like a painter, can likely deduct the costs associated with creating the NFT. 

For the buyer, things can get complicated.  Under most circumstances the NFT is purchased using cryptocurrency, such as Ether.  The IRS treats cryptocurrency as property, similar to stock, not cash.  This results in a sale of Ether, triggering a taxable event.  The buyer would pay tax on the difference between the sale price and basis.  The buyer’s basis in the NFT becomes the purchase price.  If you purchase an NFT using substantially appreciated cryptocurrency, you can imagine scenarios where the buyer doesn’t have the cash to pay the tax.  Walk into an art gallery and pay cash, your purchase doesn’t trigger any tax.  Buying an and NFT, however, will.  This different treatment may not be fair, but that never got in the way of taxes.  It is also possible that the NFT could be considered a collectible under IRC section 408(m), which would trigger a higher tax.

The IRS is hoping Congress approves a substantially higher budget and expects to use it to increase enforcement efforts.  Cryptocurrency is one of the IRS’s highest priorities and you can bet people buying and selling NFTs are going to stumble into tax trouble.  Dapper Labs has stated it will not issue 1099s so taxpayers will have to keep their own records.  Whether NFTs are a fad or here to stay, buyers and sellers need to be aware of the tax issues involved.     

Jonathan Kalinski is a principal at Hochman Salkin Toscher Perez, P.C. and specializes in both civil and criminal tax controversies as well as sensitive tax matters including disclosures of previously undeclared interests in foreign financial accounts and assets and provides tax advice to taxpayers and their advisors throughout the world.  He handles both Federal and state tax matters involving individuals, corporations, partnerships, limited liability companies, and trusts and estates. Mr. Kalinski has considerable experience handling complex civil tax examinations, administrative appeals, and tax collection matters.  Recently, he has focused on the taxation of cannabis and cryptocurrency.  Prior to joining the firm, he served as a trial attorney with the IRS Office of Chief Counsel litigating Tax Court cases and advising Revenue Agents and Revenue Officers on a variety of complex tax matters.  Jonathan Kalinski also previously served as an Attorney-Adviser to the Honorable Juan F. Vasquez of the United States Tax Court.

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