There is no place to hide: Will NFT be taxable?

By Daniel Shin

NFT stands for non-fungible token. It is a fancy term for a unique digital asset that is associated with blockchain technology. Regardless of the recent ups and downs of cryptocurrencies, businesses relating to NFTs have rapidly expanded. It encompasses both tangible and intangible assets such as music, fine art, sports, hard jewelry, virtual goods and more. NFTs will likely continue their double-digit growth in the coming years despite the recent troubles with cryptocurrencies.

Korea had once taken up almost 30 percent of global cryptocurrencies and NFTs trade. Perhaps zero tax on digital assets has propelled the adoption of NFTs. Due to its popularity, the National Tax Service (NTS) has announced that NFTs will be taxed in the coming years. However, there are yet no clear rules, regulations or even taxable legal definitions concerning NFTs or more broadly, digital assets ― although legislators have been working on it.

NFTs have come to prominence on a global scale as a way for creators to get fair compensation for their creative endeavors. It is also helpful for collectors to access a new types of investment-worthy asset(s) with ease. Each NFT comes with a unique ID that is instrumental in its verifiable transaction history. This information is traceable and secure as it is stored in the blockchain.

Selling an NFT with cryptocurrencies, fiat money, other NFTs, or any goods or services is considered a taxable event. Creators who use NFTs to digitize their original work will be interested in monetizing it by selling the equivalent of its original. Creators still maintain original authorship of their work, and they may produce and sell other copies. However, the unique digital code assigned to each NFT acts as proof of ownership. Hence, when an NFT is sold, it is a taxable event. The buyer may also have to pay taxes.

NFTs are taxable. They should be taxed like other assets. However, the process is not going to be that simple. Until further guidance is announced for NFT transactions, taxpayers must apply existing principles of current tax laws to NFT transactions. For example, the Internal Revenue Service (IRS) in the United States, increasingly, has issued specific guidance on the tax treatment of cryptocurrencies in recent years. The IRS has also included NFTs in discussions of broader digital assets.

Despite the strong interest in NFTs, there is no specific legislative guidance currently available in Korea regarding whether NFTs are taxable or not. If so, what is a fair tax rate and tax base of NFTs? In order to delve into and discuss NFT-related tax issues, the first step would be to establish a sound legal definition of what an NFT is.

In summary, NFT transactions may be viewed as the transfer of a virtual asset or an investment-worthy contract, or simply a right to the underlying asset, such as copyright. In 2022, the IRS released a draft stating that NFTs will be considered digital assets, similar to cryptocurrencies. If NFTs are sold for profit, they will be considered as a Capital Gains or Collectible in the tax definition. There is an additional tax aspect that also needs to be considered for sellers of NFTs that have seen a rise in value in recent years: Works of art in real life, for example, are considered collectibles and are taxable at a higher rate of 28 percent.

One thing to remember, though, NFTs differ from cryptocurrencies. Hence, taxpayers should not treat NFTs in the same manner that we treat cryptocurrencies. Unlike major cryptocurrencies such as Ethereum, which are fungible, NFTs are not interchangeable with each other. In theory, they cannot be directly exchanged for other currencies, goods or services. However, a growing number of NFTs are attached to real collectibles, not virtual ones. Oftentimes, they are actively changing hands. NFTs that are attached to hard jewelry or expensive cars, for example, are actively traded in respective vertical NFTs.

Many policymakers think that NFT holders owe taxes. Because cryptocurrencies are not the same as fiat currencies such as dollars. Buying with cryptocurrencies is more like selling a stock to get the money to buy an art piece. When an NFT is purchased with cryptocurrencies, the gain or loss on the cryptocurrencies that are used must be calculated for tax purposes. They could be taxed as a short-term or long-term capital gain, though.

You will likely have to pay taxes upon the sale of NFTs in the near future. If you are a creator, it will be taxed as ordinary income. Subsequent owners of NFTs, will be taxed differently depending on the use case and the length of duration that the asset has been held for. It is not yet 100 percent clear if tax authorities will classify NFTs as collectibles any time soon. Holders must pay taxes upon purchasing NFTs due to the disposal of their cryptocurrencies. When you purchase NFTs with cryptocurrencies, it will also trigger a taxable event as you will have to pay taxes on any capital gain from your cryptocurrency trading. If NFTs are eventually classified as a collectible, which is also not impossible, they will be subject to the 28 percent capital gains rate in the case of the U.S. like other collectible assets such as stamps, artwork and precious metals.

NFTs are a new type of asset. Current tax law is slow to adapt and does not have provisions specifically related to the tax treatment of NFTs. All tax treatments outlined in various forecasts are as of yet, quite speculative and based on existing tax laws. If you are investing in NFTs, you must be sure to keep good records of your transactions and seek relevant support from tax professionals with domain expertise. Relatively soon after tax authorities release additional guidance, the taxation of NFTs will become clearer. No matter what the law says, proper documentation and evidence of your purchases and sales history will minimize potential tax risks in the near future.

Daniel Shin is a venture capitalist and senior luxury fashion executive, overseeing corporate development at MCM, a German luxury brand. He also teaches at Korea University.