In the digital realm, all taxes aren’t necessarily equal.
Amid a cryptocurrency and non-fungible token (NFT) boom, wealthy owners may pay a different tax rate on investment growth in such holdings.
Specifically, an investor who sells an NFT, such as digital art, may owe a top 31.8% federal tax rate on any earnings. By comparison, appreciation in bitcoin, ethereum and other digital coins is subject to a 23.8% top rate.
That’s because NFTs are likely collectibles, for tax purposes. Collectibles carry a higher maximum tax rate on capital gains relative to assets like stocks, bonds and cryptocurrencies.
The IRS hasn’t explicitly said that NFTs are collectibles, leaving some room for interpretation. But many tax experts think they clearly belong in the same group as art, antiques, gems, metals, stamps and coins — which the IRS has labeled as tangible collectibles subject to the higher tax rate.
“I don’t see how it’s not a collectible,” said Jeffrey Levine, a St. Louis-based certified financial planner and accountant at Buckingham Wealth Partners, of NFTs.
NFT, crypto boom
NFTs are essentially one-of-a-kind digital assets, which can extend beyond art to things like tweets and GIFs.
The NFT market has grown quickly. Sales hit $6 billion in the third quarter of 2021, up from about $22 million the year before, according to NonFungible.com. In March, Christie’s became the first major action house to sell NFT-based virtual artwork; the piece sold for $69 million.
The numbers of NFT buyers has also swelled — to about 260,000 in the third quarter of last year, from 19,000 during the same period of 2020.
Similarly, a crypto craze has gripped investors of late. More than 10% of American adults own cryptocurrency, with almost two-thirds buying in over the past year, according to a 2021 CNBC survey.
Capital gains tax
Investors pay capital gains tax when they sell an asset. The levy is owed on any appreciation that accrued since purchase.
The IRS generally taxes long-term capital gains at a top 20% federal rate. Long-term gains apply to crypto and other assets owned more than a year.
In 2021, a single person with taxable income of more than $445,850 paid the 20% top rate. (Less affluent individuals pay a 0% or 15% capital-gains tax rate, depending on income.)
Wealthier individuals also owe a 3.8% surtax on investment income, which kicks in at more than $200,000 of income for singles — for a total 23.8% federal tax rate on capital gains.
However, collectibles — which tend to be owned by the super-wealthy — are subject to a different tax regime.
Their long-term capital gains are taxed at a higher top federal rate, of 28%, and kick in at different income levels. The 3.8% surtax also applies.
So, a wealthy NFT owner could owe up to 31.8% in federal taxes on the appreciation.
“If you have artwork or a classic car, for example, you’re [likely] a super-high-net-worth individual, which is why the IRS has this special long-term capital-gains tax rate,” said Shehan Chandrasekera, an accountant and head of tax at CoinTracker.
How the tax works
Confusingly, different income thresholds apply to capital gains taxes for collectibles, according to Troy Lewis, an associate professor of accounting and tax at Brigham Young University.
Investors pay ordinary income-tax rates on collectibles’ appreciation, up to a maximum 28%. (There are seven marginal income tax rates — 10%, 12%, 22%, 24%, 32%, 35% and 37% — which correspond with income.)
“If your ordinary rates are below 28%, you pay your ordinary rates,” Lewis, who also owns an accounting firm in Draper, Utah, said of collectibles.
For example, a single taxpayer in the 22% tax bracket — which applied to income between roughly $41,000 and $86,000 last year — would pay a 22% top rate on the long-term appreciation of collectibles.
Conversely, someone in the 37% bracket — which applies to income over about $524,000 — would see their collectible rate capped at 28%.
In both examples, the taxpayer would owe a higher tax rate on NFT appreciation than that of crypto.
Though prevailing thought among tax practitioners seems to be that NFTs are collectibles, the matter isn’t necessarily closed.
The IRS lists art and other “tangible personal property” as a collectible. NFTs likely fall under the “art” category, placing them in the collectible category; but NFTs are also intangible — placing them in a murky area of tax law.
“Is it a collectible?” Lewis said. “It’s not well settled yet because it’s still a brand-new area.”