NFTs and tax are now on the radar of the Australian Tax Office (ATO). There are few things you now need to know, as we approach tax season. Buying, selling, minting NFTs, as well as getting free NFTs airdropped to your wallet, are now all potentially taxable events. And if you have bought NFTs with crypto, you need to report it to the ATO.
Yes, that’s right, you need to report when you use any cryptocurrency to buy NFTs. This is because if you bought crypto a while ago, and it has gained in value, when you “dispose” of it to buy the NFT, the capital gains that you have made on the life of that cryptocurrency needs to be declared. If you have lost money on that crypto, you may still need to report this.
For the NFT enthusiasts out there who have a back catalogue of trades to now report, it may seem overwhelming, but you can take a short cut by using software to do it for you. There are several companies that offer such software in Australia, such Koinly and CryptoTaxCalculator. They can keep track of your NFT trades as well as your crypto trades, as long as you tell the software where all your wallets are. The software automates a report and spits it out at tax return time, so you don’t have to keep track of all your trades in the financial year. You can hand this report to your accountant, or use it to do your own tax return.
NFTs and tax: How does it work?
Taxation of NFTs follow the same principles as cryptocurrency. This means that the following activities will trigger a taxable event:
-Selling NFTs for crypto
-Exchanging one NFT for another NFT
-Giving a NFT as a gift (unless it is to a tax deductible gift recipient like an Australian charity)
-Buying an NFT with crypto.
Shane Brunette is the CEO of CryptoTaxCalulator, and says there are a few things that NFT aficionados need to be aware of. For example, if you get a free NFT airdropped into your wallet, this could be a taxable event. Brunette explains, “If you get gifted a Bored Ape NFT, well then that’s going to be quite significant — it might be worth $10,000 or more. You definitely need to be aware that there are probably some tax implications there.”
Even for free NFTs, you may need to report them, depending on the circumstances as to how they arrived in your wallet.
What if you just buy an in-game NFT, like a gun?
NFT gaming has the potential to trigger multiple tax events.
-Anyone who creates an NFT item and then sells it in a game may be required to pay tax on the sale.
-Buyers of these NFT items may owe capital gains tax on the crypto used to pay for them.
-If NFT items are traded with other gamers, this could be a taxable event.
-If you misplace any of these items, it may not qualify as a loss.
NFTs and Tax: Examples of NFT tax situations
According to the ATO, the tax treatment of an NFT depends on your circumstances, the way you use the NFT and your reasons for holding and transacting with the NFT.
Here is an example scenario that the ATO gave The Chainsaw. There are three people in this scenario, and all three have a different tax event that is triggered by the initial sale of the NFT.
Kim, a professional artist, paints a portrait of a famous Australian and decides to create 10 NFTs, each of which provides the right to a 4-hour private viewing of the portrait in her gallery each year for up to 20 people.
Jo is a relative of the portrait’s subject. She buys the NFT and uses the private viewing to celebrate the subject’s birthday with close family and friends every year.
Osman buys one of Kim’s NFTs. He runs an art tour business, and he plans to use the private viewing of the portrait as part of an annual art tour of the region.
So how do each of these people approach the tax situation?
According to the ATO, “The proceeds of the initial sale of the NFTs is assessable as business income to Kim.”
The digital contract for the NFTs says that Kim will get a commission of the sale price sent back to her as the original artist, every time the NFT gets sold on. This means that whenever an NFT is sold to a new owner, Kim receives a percentage of the sale amount.
Kim owns the original painting and any additional rights, such as reproduction rights or commercial licensing. Money from the initial sale of the NFTs are classified as “business income” and will be taxed as part of her business earnings.
If the NFTs keep changing hands, earning her more income from being allocated a portion of the sales, this also is treated as “business income.”
If Kim decides to end her business, but still receives commissions from NFTs changing hands into the future, this will be classified as “ordinary income” and is still subject to tax.
Jo uses the NFT to gain access to private viewings of the painting. According to the ATO, “For Jo the NFT is a personal use asset.”
What this means is that Jo is making personal use of the NFT. In this context, “personal use asset” means that Jo is using it for enjoyment, rather than financial gain or speculative investment. So, this is not a taxable event (if she paid Australian dollars for the NFT).
Osman buys the NFTs so he can bring people to see the painting as part of his business. According to the ATO, “For Osman, the NFT is a capital asset of a business.”
So, when he sells the NFT, he will pay capital gains tax (as long as the NFT has risen in price). The capital gains tax is typically calculated based on what price was paid to buy it, and what it was sold for.
Here’s the good news for Osman. He may deduct the costs associated with buying and holding the NFT as a business expense.
If Osman’s art tour does well, then he will be taxed on the income from it, including the part of the tour that comes from the private viewing experience. This is separate from the capital gains tax.
NFTs and Tax: Types of NFTs
While the ATO is all over NFT taxation, there are other areas that are still unclear, according to Brunette. “The NFT itself is just a digital certificate. And what does that digital certificate represent? Is it an image, or is it a piece of real estate? What is the underlying asset that’s represented by this digital certificate? NFTs might actually represent a piece of property so that’s going to have very different tax consequences to digital artwork. You start talking to the grey areas of the tax code very quickly.”
Taxes on NFTs are certainly complex. “You may have a transaction where you dispose of one Ethereum token to create five or ten NFTs. Then you’ve got to work out the profit of each one, by doing multiple calculations and keeping appropriate records. This is where the software can help keep track of all these transactions.”
NFTs and Tax
And don’t think that the tax office can’t find your NFT transactions. Brunette explained, “You might say, how do the ATO know that they’re your transactions on the blockchain? There’s on-ramps and off-ramps, where Australian dollars get into the system and out of the system.”
This requires identification, and Brunette says that the ATO has the capability to track this. “The data is there. The biggest misconception is that blockchain activity is anonymous. It clearly isn’t. Anyone can have a look at the transactions.”
Brunette says that NFT users tend to be younger. “They may be at their desk late at night trading NFTs and not thinking about tax, but they really should. It might be the very first time that they’ve had to think about putting aside money to pay for tax because they’re used to the system where their employer just does tax for them. And all of a sudden they have a $50,000 tax bill, and they just bought a car, and don’t have $50,000 any more. We see it all the time.”
Death and taxes are the only certain things in life, as the saying goes, and it even effects your NFTs. Happy tax time, non-fungible token lovers!