NFTs as Collectibles: Tax Implications for US Investors

The IRS has signaled its intent to treat certain NFTs as collectibles, which could subject them to a higher capital gains tax rate of up to 28%. In March 2023, the IRS released Notice 2023-27, outlining how it plans to determine whether an NFT qualifies as a collectible. This guide explains what this means for US investors, how the look-through analysis works, and how to handle NFT collectibles on your tax return.

What are collectibles under US tax law?

Under Section 408(m) of the Internal Revenue Code, collectibles include:

• Works of art
• Rugs and antiques
• Metals and gems
• Stamps and coins
• Alcoholic beverages
• Any other tangible personal property specified by the IRS

Collectibles have always been subject to special tax treatment in the US. While most long-term capital gains are taxed at preferential rates of 0%, 15%, or 20%, gains from the sale of collectibles held for more than one year are taxed at a maximum rate of 28%.

IRS Notice 2023-27: NFTs as collectibles

On March 21, 2023, the IRS released Notice 2023-27, announcing its intent to issue guidance on when NFTs should be treated as collectibles for federal income tax purposes.

The notice introduced a "look-through" framework that examines the asset or right associated with an NFT, rather than the NFT itself, to determine whether it qualifies as a collectible.

This was the first time the IRS provided specific guidance on how NFTs should be classified for tax purposes, and it has significant implications for NFT investors and creators in the US.

The look-through analysis explained

The IRS's look-through analysis works by examining what the NFT represents or is associated with, rather than treating the NFT as a standalone digital asset.

Under this framework:

1. Identify the associated right or asset – Determine what the NFT certifies ownership of or grants a right to.
2. Apply the collectibles definition – Check whether the underlying asset or right falls within the definition of a collectible under Section 408(m).
3. Classify the NFT – If the underlying asset is a collectible, the NFT itself is treated as a collectible for tax purposes.

Which NFTs are considered collectibles?

Based on the look-through analysis, the following types of NFTs are more likely to be classified as collectibles:

• Digital art NFTs – NFTs representing works of art (digital paintings, illustrations, generative art) may qualify as collectibles since "works of art" are explicitly listed in the collectibles definition.
• NFTs linked to physical gems or metals – NFTs certifying ownership of physical precious metals, gems, or jewelry.
• NFTs linked to antiques or rugs – NFTs representing ownership of physical antiques or similar items.
• NFTs linked to rare wines or spirits – NFTs certifying ownership of alcoholic beverages.

NFTs that are less likely to be classified as collectibles include:

• Virtual real estate NFTs – NFTs granting rights in virtual worlds (e.g., Decentraland, The Sandbox).
• Utility NFTs – NFTs that provide access to services, events, or memberships.
• Gaming NFTs – NFTs representing in-game items, characters, or assets.
• Music and media NFTs – NFTs granting rights to music or video content (though this is debatable).

How are NFT collectibles taxed?

Short-term gains (held 1 year or less)

If you sell an NFT collectible within one year of purchasing it, the gain is taxed as short-term capital gains at your ordinary income tax rate (10% to 37%). This is the same treatment as any other crypto or NFT sale held short-term.

Long-term gains (held more than 1 year)

If you sell an NFT collectible after holding it for more than one year, the gain is taxed at the collectibles capital gains rate, which has a maximum of 28%. This is higher than the standard long-term capital gains rate (maximum 20%) that applies to most other capital assets.

The actual rate you pay depends on your income and tax bracket, but it will not exceed 28% for collectible gains.

The 28% collectibles tax rate

The 28% maximum rate for collectibles is a long-standing provision in the US tax code. Here is how it compares to standard long-term capital gains rates:

• Standard long-term capital gains – Maximum rate of 20% (plus potential 3.8% Net Investment Income Tax).
• Collectibles long-term capital gains – Maximum rate of 28% (plus potential 3.8% Net Investment Income Tax).

This means a taxpayer in the highest bracket could pay up to 31.8% on long-term gains from NFT collectibles, compared to 23.8% for standard long-term capital gains.

NFTs in IRAs and the collectibles rule

The collectibles classification has additional implications for investors holding NFTs in Individual Retirement Accounts (IRAs).

Under Section 408(m), if an IRA purchases a collectible, the purchase is treated as a taxable distribution to the IRA holder in the amount of the collectible's fair market value. This means:

• The distribution is subject to income tax.
• If the IRA holder is under age 59 and a half, an additional 10% early distribution penalty may apply.
• This effectively prohibits IRAs from investing in collectible NFTs without triggering immediate tax consequences.

How to determine if your NFT is a collectible

To determine whether your NFT may be classified as a collectible, ask yourself:

1. What does the NFT represent or certify ownership of?
2. Does the underlying asset fall into any of the collectible categories (art, gems, metals, antiques, stamps, coins, alcoholic beverages)?
3. Does the NFT primarily serve a utility purpose (access, membership, gaming) or is it primarily a collectible item?

If the underlying asset is clearly a collectible, the NFT should be treated as one for tax purposes. When in doubt, consult with a tax professional experienced in crypto taxation.

How to report NFT collectibles on your tax return

Report NFT collectible gains and losses on your US Individual Income Tax Return:

• Short-term gains/losses – Report on Form 8949, Part I, and Schedule D, Part I.
• Long-term gains/losses (collectibles) – Report on Form 8949, Part II, and Schedule D, Part II. Long-term collectible gains are reported on line 28 of Schedule D, which is subject to the 28% maximum rate.
• NFT income (for creators) – Report on Schedule C or Schedule 1 as ordinary income.

How to reduce NFT collectibles taxes

Strategies to reduce your NFT collectibles tax bill:

• Tax loss harvesting – Offset collectible gains with losses from other NFT or crypto trades.
• Donate NFTs – Donate appreciated NFTs to qualified charities for a tax deduction.
• Evaluate the classification – Not all NFTs are collectibles. Utility and gaming NFTs may qualify for the standard long-term capital gains rate.
• Offset with short-term losses – Short-term capital losses can offset collectible gains dollar-for-dollar.
• Track gas fees – Include gas fees and transaction costs in your cost basis to reduce taxable gains.

How CoinTracking helps with NFT taxes

CoinTracking simplifies NFT tax tracking and reporting:

• Automatically import NFT transactions from Ethereum and other blockchains.
• Track the cost basis and FMV of each NFT purchase and sale.
• Calculate capital gains and losses for your NFT portfolio.
• Generate IRS-ready tax reports including Form 8949 and Schedule D.

Conclusion

IRS Notice 2023-27 introduced important guidance on how certain NFTs may be classified as collectibles, potentially subjecting them to a higher 28% long-term capital gains tax rate. Understanding the look-through analysis and how it applies to your NFTs is crucial for proper tax planning and reporting. Use tools like CoinTracking to keep accurate records of all your NFT transactions and ensure compliance with IRS requirements.