IRS seeks feedback on definition of NFTs

The U.S. Internal Revenue Service (IRS) announced this week that it is seeking feedback regarding the tax treatment of NFTs as collectibles under tax law that will inform upcoming guidance. Specifically, it is soliciting comments on:

  • The treatment of NFTs as collectibles and other questions such as whether the IRS has accurately defined NFTs;
  • Its use of a look-through analysis to determine whether a digital asset may be taxed as a collectible, as opposed to a capital asset, which is currently the treatment used for sales or exchanges of digital assets;
  • The factors it should use to consider whether an NFT is a collectible for tax purposes;
  • Whether there are any issues with applying the tax treatment for collectibles to individually directed accounts under a qualified plan; and
  • What other guidance related to NFTs would be helpful.

Comments are due on June 19, 2023. Importantly, the IRS defines an NFT as "a unique digital identifier that is recorded using distributed ledger technology and may be used to certify authenticity and ownership of an associated right or asset." And it acknowledges that "[o]wnership of an NFT may provide the holder a right with respect to a digital file (such as a digital image, digital music, a digital trading card, or a digital sports moment) that typically is separate from the NFT." (footnote omitted). It also acknowledges that NFTs may provide certain rights, such as attending an event, or proving ownership of a physical item. This helps distinguish NFTs, which are not intended to be financial in nature, from other types of digital assets. In other words, the IRS is taking a step towards a sensible token classification system by expanding on its guidance for digital assets.

The notice provides that the proposed treatment of NFTs as collectibles would fall under a provision of the tax code that applies to collectibles held within individual retirement accounts, and the sale or exchange of a collectible held for over one year would be subject to a maximum 28%perc capital gains tax (as opposed to a lower tax rate for capital assets). Per the IRS’ look-through analysis, an NFT would be treated as a collectible for tax purposes if the asset or associated right tied to the NFT also meets the definition of a collectible. The tax laws state that works of art, rugs or antiques, metals or gems, stamps or coins, alcoholic beverages, or certain tangible personal property are considered collectibles. For example, an NFT representing ownership of a stamp would be treated as a collectible. On the other hand, NFTs representing objects outside of this category would not be classified as collectibles. Where further analysis is required is whether a collectible constitutes a “work of art,” an area where the IRS is requesting feedback.

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