The IRS Eye is on NFT’s and Cryptocurrencies

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The Crypto market capitalization, calculated by multiplying price of the cryptocurrency by the number of coins in circulation, went over $1 trillion in 2021. A substantial portion of the market capitalization relates to the nonfungible token (“NFT”) market. NFT sales volume totaled $24.9 billion, $4.8 billion of which is related to NFT gaming. For perspective, Crypto market capitalization in 2020 was $758 billion and the total sales in the NFT market in 2020 was just $340 million.

The IRS issued a “John Doe” summons to Coinbase back in 2016. It was looking for the transaction history of Coinbase users between 2013 and 2015. Coinbase was required to provide user information who bought, sold, sent, or received cryptocurrency of at least $20,000 in value in one year. Based on the information received, the IRS sent 10,000 letters to taxpayers advising them of their failure to properly report cryptocurrency-related transactions. In 2021, the IRS issued John Doe Summons to Payward Ventures and Internet Financial, seeking similar information for 2016-2020. In March of 2021, the IRS started Operation Hidden Treasure to enforce violations of tax related to cryptocurrency. And in case you missed it, there was a question on the 2020 tax return about this (since there is already one for 2021). For 2021, it asks “did you sell/buy/exchange any financial investments?”

The IRS released FAQs relating to virtual currency and reaffirmed that the disposition of virtual currencies is a disposition of property. The strategy they suggest is whether the virtual currency is sold for real currency or exchanged for other property, capital gain or loss will apply as would be expected with any other type of property. A lot of crypto holders forget that exchanging one coin for another, a crypto-to-crypto exchange, is considered a taxable event.

A taxpayer that uses virtual money to buy goods will recognize a capital gain or loss, depending on the time they held it. The gain is calculated by seeing the difference between the cost of one coin and the amount you sell them for. The value you will realize may be in USD, or the fair market value of the property received. The basis is what you originally paid for your virtual currency.

Non-fungible tokens (NFTs) are created on top of Ethereum, so every item is unique. That is different from most games which use the same token to represent different items – in this way, it is like a set of collector cards. You are unable to purchase an NFT without owning the cryptocurrency Ethereum.  NFTs can be copied and downloaded by anyone but only the person who owns the original NFT has true ownership of it. It sounds like you may have seen the famous painting, Starry Night by Vincent Van Gogh. You might own a print of it in your home, but only the Museum of Modern Art owns the original. The Ethereum blockchain can also benefit the content author with a built-in royalty fee. When you upload your work to places like Fiverr, 10% of all future sales of your work are deposited in your virtual currency wallet. Provided a creator’s digital work remains popular, the creator could have a royalty income stream for an indefinite period depending on the way the contract was written.

It is important to note that the IRS has not taken a formal stance on the tax treatment of NFTs to this date. It is possible that NFTs could receive the same tax treatment as cryptocurrency, which would be taxed as property with a long-term capital gains tax rate that varies from 0 – 20% based on your income. Alternatively, NFTs could receive similar tax treatment to stamps, antiques, or trading cards, and be taxed at the collectibles tax rate, which is significantly higher at 28%.

But there could be a difference in how they are held depending on the type of asset. For example, assets that are held for less than 1 year will be subject to short-term capital gains tax rates, while those that have been held for over 1 year will be available to lower long-term capital gains tax rates.

If you are making or investing in something like a blockchain token, it is important to understand that the more transactions you do, the more complicated NFT taxes get to keep track of. Most exchanges do not provide 1099 forms with info on a cost basis, so it is best to document all transactions from the very start to avoid any incorrect calculations.

In this article, we tried to explain the IRS’s approach to cryptocurrencies and NFT, which has become widespread and extremely popular. You can follow our social media accounts to get the most up-to-date information on these issues, which are still unclear. If you have questions, you can write them in the comments or you can get consultancy by reaching our experts from our free consultancy service.

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