Nonfungible tokens, or NFTs, are perhaps best known for their association with digital artwork such as the famous Bored Apes Yacht Club series. Yet they can be used in other ways, such as to certify ownership of a physical item. The IRS has announced that it plans to offer guidance on certain tax issues related to NFTs.
The concern is whether NFTs should be treated as “collectibles” as that term is defined in the tax law. Collectibles, including stamps, coins (with some exceptions), gems, works of art, and various other items, receive unfavorable tax treatment. A purchase of collectibles within a retirement account will be treated as a distribution from that account, often with painful consequences. The maximum tax rate applied to long-term capital gain is higher for collectibles than for other assets.
The IRS will provide detailed guidance after gathering more information. In the meantime it will use a “look-through analysis.” An NFT will be treated as a collectible if its associated right or asset is a collectible. For example, an NFT that certifies ownership of a gem would be considered a collectible because gems are collectibles. What about bored apes? “The Treasury Department and the IRS are considering the extent to which a digital file may constitute a ‘work of art’” and therefore a collectible.
The NFT market is highly speculative. Most advisors would consider them unsuitable as retirement investments, even apart from any tax problems. This IRS Notice warns that NFTs in an IRA or other retirement account may lead to disaster even without a decline in value.