On March 21, 2023, the Internal Revenue Service (IRS) announced its intent to issue guidance related to the taxation of certain types of nonfungible tokens (NFTs). Notice 2023-27 is the agency’s first published document addressing this topic.
The Notice defines “NFT” as a unique digital identifier which gives owner the ability to certify authenticity and ownership of an associated right or asset. It provides that an NFT’s associated rights can grant the holder a right with respect to either digital files, such as digital music, digital trading cards, etc., or to non-digital rights and assets, such as the right to attend a concert or certify ownership of a physical item.
The Notice also addresses whether NFTs qualify as collectibles. If they did, this would mean that gains on NFTs so classified would be subject to a higher rate of capital gains tax (a maximum rate of 28%). The Internal Revenue Code (Code) treats as collectibles, among other things, works of art, rugs, antiques, metals, gems, stamps and any other tangible personal property specified in regulations.
To make this determination, the Notice states that the IRS intends to apply a “look-through analysis” based on the NFT’s associated right or asset, and whether such right or asset would be categorized as a collectible. Under this analysis, NFTs which give the holder rights to collectibles such as precious metals or physical painting, would be treated as a collectible.
In contrast, NFTs which give holders the right to purely digital assets, such as virtual land or items used solely within a video game, would not be categorized as collectibles. Thus, the regime proposed by the Notice could result in higher taxes for people who sell collectible NFTs than for people who sell non-collectible NFTs.
The Notice does not address all issues related to NFTs, and specifically requests comment from taxpayers on various other key issues related to NFT taxation. These include the proper definition of “NFT,” the Notice’s look-through analysis and its application, whether other factors should be considered in determining if an NFT is a collectible under the Code (including whether a digital file is a work of art), when an asset constitutes tangible personal property, how to treat fractional interests in NFTs, and any other issues for which guidance would be helpful.