While crypto art sales have boomed in the past month, catching the national spotlight with flashy price tags, what many buyers and sellers might not realize is that non-fungible tokens or NFTs can generate a large tax bill.
In March, a crypto art piece by digital artist Mike Winkelmann, also known as Beeple, made history when it sold for nearly $70 million. When told how he would be taxed on the sale, Winkelmann expressed surprise.
“Holy s—, that’s a lot of taxes,” Winkelmann told CNBC.
Winkelmann may be facing a tax bill worth tens of millions of dollars. As an artist, Winkelmann will also have to pay federal and state income taxes on his earnings from the sale, in addition to reporting the cryptocurrency gains on his 2020 tax return.
The Internal Revenue Services sees buying and selling NFTs as a realization of investment gains, and therefore subject to the capital gains tax.
There are multiple ways you can get taxed when buying and selling an NFT. Capital gains taxes apply to NFTs, in much the same way they apply to selling stocks. However, because NFTs are considered collectibles they are also taxed at an even higher rate of 28%.
NFT buyers and sellers also need to be aware of how the cryptocurrency they used to buy the NFT will be taxed.
Most crypto-art pieces are bought using digital currencies, including ether and WAX. These cryptocurrencies are also subject to a capital gains tax, depending on how much they’ve gained in value since they were originally purchased and how long the buyer held the digital currency.
If the buyer held the cryptocurrency for over a year, they would be subject to a long-term capital gains tax. Long-term capital gains are taxed at 15% for individuals who earn between $40,000 and $441,000 — and 20% for individuals that make more than that amount. Holding the digital asset for less than a year will create a short-term capital gain, which is based upon the effective tax rate for the taxpayer.
In short, NFT buyers and sellers will be taxed when purchasing an NFT using a digital currency, selling an NFT for another NFT, selling an NFT for a cryptocurrency, as well as when converting the cryptocurrency used to buy and sell the item back into US dollars.
On the other hand, NFTs are not yet subject to the sales tax that would be applied to a physical piece of art — an issue that art law expert Diana Wierbicki told ArtNet state tax laws could soon catch up to.
The IRS has been cracking down on cryptocurrencies in recent months. This year, the IRS put a question about crypto investments on the first page of 2020 tax returns. People that fail to report digital assets or attempt to hide them could face serious penalties from the IRS.
Many NFT buyers and sellers likely do not know the hefty tax fees they will face. Shehan Chandrasekera, head of tax strategy at CoinTracker, told CNBC that there’s so many unknowns when it comes to the emerging market of NFTs that many people probably won’t know what to expect on tax day.
“People’s knowledge of this tax in the U.S. is very poor,” he said. “I just don’t think people know about it.”