Got NFTs? IRS Wants to Know: Are They Collectibles or Not

Non-Fungible Tokens gained popularity in recent years in the art world, gaming, sports, and other industries where there is a demand for unique digital assets. Right now, its market is in a lull as the cryptocurrency world is, but IRS has not stopped its attention on the fact that there is no express law or rule to tax the sale or trade-in NFTs.The IRS intends to use comments to develop guidance on the tax treatment of NFTs as collectibles.

IRS seeking Public View on NFTs

IRS has just released Notice 2023-27, through which they seek feedback and comments on considering the definition of Collectibles as defined in section 408(m)(2) of the internal revenue Code. If you are asking why, then there are no express rules or guidance from either law or the IRS on how to treat the sale and purchase of NFTs. So, although quite late, as the craze for NFTs is waning, IRS wants to provide clear guidance on how to tax the gain or loss on trade of NFTs.

What is Non-fungible Asset?

A non-fungible token (NFT) is a digital asset representing ownership of a unique item or piece of content, such as artwork, video, music, or other digital media. Unlike traditional cryptocurrencies like Bitcoin or Ether, each NFT is unique and cannot be exchanged for another NFT on a one-to-one basis because they have different attributes or properties that make them distinct. NFTs are recorded on a blockchain or other distributed ledger technology, which ensures their authenticity, ownership, and provenance, making them valuable for creators, collectors, and investors. 

How does the IRS want to tax NFTs?

The US Treasury Department and the Internal Revenue Service (IRS) plan to issue guidance on the tax treatment of certain non-fungible tokens (NFTs) as collectibles under section 408(m). Section 408(m)(2) provides the definition of “Collectibles” 

 [f]or purposes of this subsection, the term ‘collectible’ means-  

(A) any work of art, 

(B) any rug or antique, 

(C) any metal or gem, 

(D) any stamp or coin, 

(E) any alcoholic beverage, or 

(F) any other tangible personal property specified by the Secretary for purposes of this subsection.

 5 Specific questions for comments of the public

 Following questions are being asked through Notice 2023-27,

1. Does this notice provide an accurate definition of an NFT or are there other definitions of NFTs that should be used in future guidance? 
2. With respect to the look-through analysis—  
   1. Are there instances in which there are concerns with applying the analysis and in which an alternate analysis may be more appropriate?  
   2. What burdens does the analysis impose?  
   3. How might the analysis be applied to an NFT with more than one associated right or asset (for example, if one of the associated rights or assets of an NFT is a section 408(m) collectible but another one is not a section 408(m) collectible)?  
   4. How might the potential for the owner of an NFT to receive additional rights or assets (such as additional NFTs) due to ownership of the NFT (even in the absence of a specific contractual right under the NFT) be treated? 
3. Are there other factors to consider when determining whether an NFT is a section 408(m) collectible? For example –  
   1. What factors might be considered to determine whether a digital file constitutes a “work of art” under section 408(m)(2)(A)? 
   2. What factors might be used to determine whether an asset is “tangible personal property” under section 408(m)(2)(F), particularly in the context of digital files?  
   3. What factors might be relevant if the NFT’s associated right is less than full ownership of an asset (for example, if the associated right is simply personal use of a digital file)? 
4. Does the application of section 408(m) to an individually directed account under a qualified plan raise any issues other than those raised for individual retirement accounts?  
5. What other guidance relating to NFTs would be helpful?

If you want to say something on the questions posed by the IRS, send your comments before June 19, 2023, to the IRS electronically via the Federal eRulemaking Portal at www.regulations.gov  or by mail to:

Internal Revenue Service,

Attn: CC:PA:LPD:PR (Notice 2023-27), Room 5203 P.O. Box 7604, Ben Franklin Station,Washington, D.C. 20044.