Crypto Update: NFTs in the Crosshairs as Collectibles

In a recent Notice issuance, the IRS and Treasury put taxpayers on notice that they intend to issue guidance related to the treatment of certain nonfungible tokens (“NFTs”) as collectibles under IRC § 408(m). Notice 2023-27 does not itself pass any regulations but instead puts taxpayers on notice for future guidance and that the IRS will be looking to apply a “look-though” analysis with respect to the taxation of NFTs.

What is an NFT?

An NFT is a digital token that serves as a unique digital identifier that is recorded using distributed ledger technology. NFTs can also be used to certify ownership and authenticity of real world rights and assets. Distributed ledger technology, such as blockchain technology, uses independent digital systems to record, share, and synchronize transactions, the details of which are recorded simultaneously on multiple nodes in a network. A token is an entry of data encoded on a distributed ledger. A distributed ledger can be used to identify ownership of both fungible tokens and NFTs.

Currently, NFTs are associated with digital files, including images, music, trading cards, and sports moments. A useful example of a prominent NFT are the digital artworks of Bored Ape Yacht Club. These digital artworks are regularly traded and many trade well above $100,000.[1]

Look-Through Analysis

Currently, the IRS and Treasury are proposing a “look-through” analysis. Specifically, if the asset to which the NFT relates is an asset specified under IRC § 408(m), then collectible treatment would likely ultimately apply. For example, in the case of an NFT representing a Bored Ape Yacht Club image is sold for a profit, then the gain on the sale would be tax at the collectible rate (discussed further, below) versus the long-term capital gains rate, provided the asset has been held for greater than one year. Alternatively, if the underlying asset is an interest in a piece of real estate or business interest, then it the collectible tax would likely not apply. The government’s approach on the “look-through” analysis really does look through the NFT itself to the underlying asset and then treats the sale or exchange as a sale or exchange of the underlying asset for tax purposes.

Collectibles, Why Does This Matter?

Collectibles Under Section 408(m)

Since NFTs can relate to ownership in certain digital assets, including art, and since art is generally taxable as a collectible, it should come as little surprise that the government is considering taxing most NFTs as collectibles. IRC § 408(m)(1) provides that the acquisition by an individual retirement account (IRA) of a collectible shall be treated as a distribution from the IRA equal to the cost to the IRA of the collectible. This same section also provides that the acquisition by an individually directed account under a qualified plan under IRC § 401(a) of a collectible shall be treated as a distribution from the account equal to the cost of the collectible.

IRC § 408(m)(2) provides identification of certain assets constituting collectibles, including (A) any work of art, (B) any rug or antique, (C) any metal or gem, any stamp or coin, (E) any alcoholic beverage, or (F) any other tangible personal property specified by the Secretary for purposes of this subsection.

Enhanced Tax Rate for Collectibles

The more significant implication of the collectible status would appear to be the increased tax rate for collectibles. Instead of the typical long term capital gains rate, collectible rates will apply under IRC § 1(h)(4) and (5). Here, instead of the top rate being 20%, it is 28%, which is a 40% increase in the tax liability associated with gains on NFTs.

IRS Requests for Comment

As part of the Notice, the IRS and Treasury request comments from interested taxpayers on any aspect of NFTs that might affect the treatment as a collectible. Specific questions are as follows:

  1. Does this notice provide an accurate definition of an NFT or are there other definitions of NFTs that should be used in future guidance?
  2. With respect to the look-through analysis –
    1. Are there instances in which there are concerns with applying the analysis and in which an alternate analysis may be more appropriate?
    2. What burdens does the analysis impose?
    3. How might the analysis be applied to an NFT with more than one associated right or asset (for example, if one of the associated rights or assets of an NFT is a collectible but another one is not?
    4. How might the potential for the owner of an NFT to receive additional rights or assets (such as additional NFTs) due to ownership of the NFT (even in the absence of a specific contractual right under the NFT) be treated?
  3. Are there other factors to consider when determining whether an NFT is a collectible? For example –
    1. What factors might be considered to determine whether a digital file constitutes a “work of art” under IRC § 408(m)(2)(A)?
    2. What factors might be used to determine whether an asset is “tangible personal property” under IRC § 408(m)(2)(F), particularly in the context of digital files?
    3. What factors might be relevant if the NFT’s associated right is less than full ownership of an asset (for example, if the associated right is simply for personal use of the digital file?
    4. Does the application of IRC § 408(m) to an individually directed account under a qualified plan raise any issues other than those raised for individual retirement accounts?
    5. What other guidance relating to NFTs would be helpful?


For those invested in NFTs, this Notice provides some reasonable expectation with respect to tax treatment. The treatment is not surprising, but still may surprise some retail investors not familiar with taxation of collectibles. Additionally, with more retirement accounts investing in digital assets, including cryptocurrency and NFTs, the IRC § 408(m) rule may create some heartache by the constructive distribution treatment for certain account acquiring collectibles. We will await the further guidance from the Service for now, but it would certainly seem that there will be a treatment of NFTs potentially as collectibles, provided the look-through analysis shows the NFT to relate to an underlying collectible asset, as defined in IRC § 408(m).



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