Original Compilation: Cecilia, bfrenz DAO

Original Compilation: Cecilia, bfrenz DAO

Cryptocurrencies are still in their early stages of development, and NFT is a brand new asset class that has only gradually gained widespread attention since the launch of CryptoPunks in 2017. Digital currency ownership is being rapidly realized and promoted, and various policies and laws are still adapting and digesting this new fact, which is understandable.

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TL；DR：

According to a notice of proposal published on March 21, the IRS plans to tax NFTs as collectibles.

It is currently in the process of releasing proposals and soliciting public opinions, and has not yet been finalized.

The IRS intends to use "pivot analysis" to determine whether an NFT is a collectible. Following the public call period, final guidelines will be published.

According to the content of the proposal, NFT will be defined as a collection and taxed according to the collection, with a maximum long-term capital gains tax rate of 28%. Other assets, such as stocks and cryptocurrencies, generally only have a top 20% federal tax rate.

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Interpreting current IRS guidance on NFTs

Historically, only five asset classes have been classified as collectibles under IRC Section 408: art, rugs or antiques, metals or precious stones, stamps or coins, and alcoholic beverages. Section 408 gives the IRS the authority to define new collectibles, but specifically states that these must be "tangible personal property." Miles Fuller, head of the government department at cryptocurrency tax firm Tax Bit and former IRS chief attorney, called it a "legal quandary." “Because in fact, the IRS cannot say on a regulatory level that they classify all NFTs as collectibles because NFTs are intangible,” he said.

Nevertheless, he believes that "Notice 2023-27" will help to clarify the tax responsibilities of NFT holders/collectors. In particular, the IRS intends to treat those NFTs associated with physical items as collectibles, an interpretation described in the document as "Look-through analysis." Basically, it will judge whether, according to the current tax law, the related rights or assets of NFT meet the standard of collectibles currently defined in the tax law, and if so, NFT is also defined as a collectible. An NFT can represent anything, really anything, so what the IRS is saying is, how it is taxed depends on what it represents.

According to the "perspective analysis method" of the IRS, when an NFT is used as a certificate of ownership of a physical asset, it will be regarded as a collectible. For example, an NFT certification of ownership of a gemstone will also be regarded as a collectible. But on the contrary, the use or development of "land" in the virtual scene is usually not a collectible, so the NFT that provides the use or development of the virtual land is usually not a collectible.

The IRS will use this “pivot analysis” until it issues NFT guidance in the coming months.

There are already some concrete examples of this kind of "pivot analysis": Fragmented NFT platform Otis selling NFTs tied to physical assets, such as rare books and trading cards; and spirits NFTs. In these cases, the NFT can function like a certificate of title or title, Fuller explained, “The IRS doesn’t necessarily tax the NFT as an asset per se, but rather it’s the connection to the physical asset that gives the NFT its value. IRS It's not trying to tax technology, it's trying to tax the economic units that technology produces. The purpose of tax law is to tax actual economic property."

In addition, the notice of proposals appears to cast doubt on whether "perspective analysis" applies to digital art files themselves, and whether digital artworks can be classified as collectibles like their physical counterparts. New York CPA Justin Macari predicts that the IRS will look closely at intellectual property rights when determining whether a digital asset is collectible. The IRS also pointed out that it is not clear whether digital files constitute "artwork" (such as writing NFT, a medium article collected as NFT). The IRS is seeking comments on this and other NFT tax-related issues, and in the notice, it listed two main issues requesting feedback:

“I think it’s fundamentally about the use of intellectual property,” Macari told CoinDesk. "I'll take an opinion with the IRS because there's a lot to say about that." Different types of NFTs may fall under different types of capital gains. Macari exemplifies Bored Ape #6723 held by Snoop Dogg. Boring Ape owners own the intellectual property rights associated with their NFTs. As Macari said, if you have a specific avatar NFT (PFP) or an NFT attached to a 1/1 NFT, you can have the right to create physical goods (sell peripherals) and open profitable companies on this basis, then This could be a definitive identifier of long-term collectible value. In contrast, NFTs that only represent digital assets (such as metaverse land), this type of NFT is closer to the IRS's definition of ordinary assets, so the two should be taxed accordingly.

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How are collectibles taxed?

Investors are required to pay capital gains tax when they sell assets. This tax is based on the seller's profit.

Short-term capital gains apply to assets held for less than a year. Profits from such sales are taxed at ordinary income rates, which also applies to wages, etc. (There are seven marginal tax rates, ranging from 10 percent to 37 percent.) Long-term capital gains apply to assets held for more than a year. These rates are usually lower than ordinary income tax rates. Stocks and cryptocurrencies are taxed at a top rate of 20%, which applies to high-income taxpayers. (Individuals with smaller incomes are taxed at 0% or 15%.)

But collections, often owned by the ultra-wealthy, are subject to a different tax regime. They have a top tax rate of 28%. They’re also structured differently: Collections are taxed at ordinary income rates, up to a maximum of 28%. This is different from the three-tier system (0%, 15% and 20%) for stocks.

In short: Americans with the highest incomes need to pay higher tax rates on their collections.

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have a thought? How to Submit Comments to the IRS

If you have thoughts on this topic, you can submit comments in writing on or before June 19, 2023. Make sure to include a reference to Notice 2023-27.

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Gray areas remain in collectibles and NFTs

Lewis said the IRS guidance "is a significant step forward for taxpayers and tax practitioners." It's also creative in how it takes old tax laws for tangible collectibles and applies them to modern digital assets.

However, there are still some gray areas in this definition of what exactly is a "collectible", and it is not always black and white, let alone the emerging NFT.

Take this scene, for example, where a person has a collection of rare cars in a garage, dedicated to collecting. However, what if another person owns the same car but drives it to work every day. Is the car a collectible, or a vehicle? Likewise, if one uses an antique table for everyday use, does it count as a collectible?

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Understanding the Future of NFT Taxation

Although the IRS guidance plan is still waiting for feedback, it can already be seen that the possibility of future taxation of the assets of NFT owners.

Individual investors who buy and trade cryptocurrencies and NFTs should be aware of the tax implications, and cryptocurrencies and NFT transactions need to start promoting relevant tax knowledge learning programs to help holders avoid future problems.

With the 28% capital gains tax replacing the previous 15% capital gains tax rate, the news could create more challenges for the NFT ecosystem that has struggled to maintain transaction volume over the past year. However, looking at it from another perspective, these more comprehensive tax measures plans may help to eliminate uncertainty in the market.

References

References

1.https://www.coindesk.com/web3/2023/03/31/how-will-nfts-be-taxed-understanding-the-irs-new-proposed-guidelines/

2.https://www.makeuseof.com/best-software-for-filing-crypto-taxes/

3.https://www.cnbc.com/2023/03/22/how-are-nfts-taxed-the-irs-plan.html