The following is a contributed article from a content partner of Benzinga

NFTs (Non-Fungible Tokens) are now the next big thing in crypto — of course, DeFi is still the overarching theme, but NFTs present a live and practical application of how decentralized technologies will upend the traditional financial industry. NFTs are simply a kind of digital token used to represent a digital or physical asset (anything of real or perceived value) to facilitate the trade, exchange, or transfer of such value in the digital world.

One of the most popular NFT sales was Jack Dorsey’s first-ever tweet, which sold was $2.9 million. The more jaw-dropping NFT sale was Beeple’s "Everydays - The First 5000 Days" art which sold for $69 million to set the stage for NFTs becoming the future of art and collectibles. Beyond the sale and purchase of NFTs by celebrities, regular people are starting to pile into the NFT business and in Q1 2021 alone, more than 25,000 NFTs have been sold with a combined value of more than $33 million.

If you missed the early days of Bitcoin, the 2017 ICO rush, and the initial DeFi momentum, NFTs may look like an attractive opportunity to ride the newest wave of innovation. However, before you start collecting and trading NFTs, you should remember nothing can be said to be certain, except for death and taxes. Hence, this piece provides a laydown on NFT taxes and how to ensure that you don’t unintentionally break tax laws. 

Tax Authorities Can And Will Tax Capital Gain On NFT Transaction

In 2014, the IRS issued Notice 2014-21, which effectively classified cryptocurrencies as property on which taxes could be applied. The IRS also went as far as showing examples of different tax principles applicable to property transactions and it showed how such tax principles are relevant to crypto transactions. 

Many other jurisdictions also have similar or are about to release policies that subject cryptocurrencies to income, capital gain, and other types of taxes. For instance, in the U.K. the HRMC has released guidance to say that individuals will be required to report capital loss or gains and to pay Capital Gains Tax when they dispose of their cryptocurrencies. 

NFTs are a new breed of cryptocurrencies, but they still fall within the general class of crypto products and services. Hence, the IRS, and reasonably, tax authorities in other countries, will logically expect you to file taxes when you buy an NFT using a fungible cryptocurrency such as Bitcoin when you sell an NFT for another NFT, or when you sell an NFT for a fungible crypto asset.

To be clear, the IRS and tax authorities in other countries won’t tax you merely for holding NFTs. However, the IRS has a “sale and other disposition of assets” rule that submits that “if you exchange virtual currency held as a capital asset for other property, including for goods or for another virtual currency, you will recognize a capital gain or loss.”

Ignorance Is Not An Excuse For Not Paying Taxes On NFTs

In 2019, the IRS started going after cryptocurrency investors for unpaid taxes, the agency reportedly sent out 10,000 letters to Americans who may have not paid taxes on their cryptocurrency transactions. The letters, labeled, Letter 6173, Letter 6174, and Letter 6174-A varied slightly depending on the individual circumstances of the recipients, and they more like “gentle” reminders about crypto tax obligations and what needs to be done to correct oversights. However, it is well understood that less “gentle” letters will follow if the tax bills remain unpaid. 

The letters were sent out months after the IRS got a court order to compel Coinbase to provide it with information about Americans who have bought at least $20,000 worth of cryptocurrencies between 2013 and 2015. However, already in 2021, the IRS has started collating a new list of people who may have defaulted on paying crypto taxes. 

As you would have guessed, there’s a hefty price to pay for non-compliance. For instance, there is a failure-to-pay penalty which starts at 0.5% of the unpaid tax amount per month but capped at 25%, which is still a very high figure that could eat into your margins. 

Secondly, there is a 5% penalty for late filing, which accrues per month starting from when the tax payment is due. The IRS encourages people to “file even if you can’t pay” to avoid the late filing penalty.  

Computing And Filing Taxes On NFTs Are Easier Than You Think

Final Words

Photo by fabio on Unsplash