The IRS may impose different taxes on NFTs and cryptocurrencies

In the digital realm, not all taxes are created equal. In the midst of the NFT craze, wealthy owners may pay different tax rates on the growth of such holdings. Specifically, investors selling NFTs may be required to pay a federal tax rate of up to 31.8% on any gains.

By contrast, the appreciation of bitcoin, ethereum and other digital coins is taxed at the top rate of 23.8%.

This is because NFTs can be collectibles in terms of taxation. Collectibles are subject to a higher top tax rate on capital gains relative to assets such as stocks, bonds and cryptocurrencies.

The IRS did not explicitly say that NFTs are collectibles, which leaves some room for interpretation. But many tax experts believe they are clearly in the same group as art, antiques, precious stones, metals, stamps and coins -- which the IRS labels as tangible collectibles, which should be taxed at a higher rate.

St. Louis CFP and accountant Jeffrey Levine of Buckingham Wealth Partners said of NFTs: "I don't see how it's not a collectible."

The boom in NFTs, cryptocurrencies

NFTs are inherently unique digital assets that can extend beyond art to things like tweets and GIFs.

The NFT market has grown rapidly. According to NonFungible.com, sales in the third quarter of 2021 reached $6 billion, which was an increase from about $22 million the year before. In March, Christie’s became the first major action agency to sell NFT-based virtual artwork, which sold for $69 million.

In addition, the number of NFT buyers has also ballooned — from 19,000 in the same period in 2020 to about 260,000 in the third quarter of last year.

Likewise, the recent cryptocurrency craze has gripped investors. According to a 2021 CNBC survey, more than 10 percent of U.S. adults own cryptocurrencies, and nearly two-thirds of them have purchased cryptocurrencies in the past year.

capital income tax

Investors pay capital income tax when they sell their assets. The levy is on any value added that accrues after the purchase.

The U.S. IRS typically levies long-term capital gains at a federal tax rate of up to 20%. Long-term gains apply to cryptocurrencies and other assets owned for more than a year.

In 2021, singles with taxable income over $445,850 pay the top rate of 20%.

Wealthier individuals are also subject to a 3.8% surtax on investment income, which kicks in when singles earn more than $200,000 -- the overall federal tax rate on capital gains is 23.8%.

However, collectibles - often owned by the super-rich - are subject to a different tax regime.

Their long-term capital gains are taxed at the higher federal top rate (28%) and additionally start at different income levels. At the same time, a surtax of 3.8% also applies.

As a result, a wealthy NFT owner could owe up to 31.8% in VAT federal tax.

Shehan Chandrasekera, accountant and tax director at CoinTracker, said: “For example, if you have art or a classic car, then you are (probably) an ultra-high net worth person, which is why the IRS has this special long-term capital gains tax rate.”

How taxes work

Confusingly, different income thresholds apply to capital gains tax on collectibles, said Troy Lewis, an associate professor of accounting and taxation at Brigham Young University.

Investors pay ordinary income tax on the appreciation of collectibles, up to a maximum of 28%.

"If your ordinary tax rate is less than 28 percent, you pay your ordinary tax rate," Lewis said of the collectible. He also reportedly owns an accounting firm in Draper, Utah.

For example, a single taxpayer in the 22% tax bracket -- which applied last year to about $41,000 to $86,000 in income -- would pay the top 22% rate for long-term appreciation of the collectibles.

Conversely, those with the 37% tax rate -- which applies to income over $524,000 -- will see their collectibles tax capped at 28%.

In both cases, taxpayers will be taxed higher on NFT appreciation than on cryptocurrencies.

unresolved issues

While the prevailing thinking among tax practitioners seems to be that NFTs are collectibles, this issue is not necessarily over.

The U.S. IRS classifies artwork and other tangible personal property as collectibles. NFTs are likely to fall into the "one said" category, placing them in the collectibles category; but NFTs are also intangible -- placing them in an obscure area of tax law.

"Is it a collectible?" Lewis said. "It's not well settled because it's still a whole new area." (Enjoy Metaverse)