The IRS has issued Notice 2023-27 in an attempt to request comments regarding the taxation of nonfungible tokens (NFTs) as Internal Revenue Code Section 408(m) collectibles. The IRS defined an NFT as “a unique digital identifier that is recorded using distributed ledger technology and may be used to certify authenticity and ownership of an associated right or asset.”
NFT trading volume peaked the week of August 22, 2021 with more than $3 billion in total sales, according to The Block.1 That number has since dropped dramatically. The total sales volume was $177 million for the week of March 12, 2023, the week before the IRS released Notice 2023-27. More than 3 million users have traded an NFT over time.
There are three categories of capital gains:
- Capital gains subject to 0/15/20% tax rates (this is the most common)
- Unrecaptured §1250 gain that is subject to a maximum rate of 25%
- Collectibles taxed at a maximum rate of 28%
Section 408(m) and Proposed Regulation 1.408-10(b) define a collectible as:
- Any work of art
- Any rug or antique
- Any metal or gem
- Any stamp or coin
- Any alcoholic beverage
- Any musical instrument
- Any historical objects (documents, clothes, etc.); or
- Any other tangible personal property specified by Treasury
Notice 2023-27 goes on to suggest that the Treasury and IRS “intend to issue guidance regarding the treatment of certain NFTs as section 408(m) collectibles.” Pending the issue of that guidance, the IRS plans to analyze whether an NFT is in fact a §408(m) collectible by “looking through” to the NFT’s associated right or asset. The notice provides an example of an NFT that certifies ownership of a gem. Since a gem is a §408(m) collectible, the NFT would be considered a collectible. A contrasting example in the notice suggests that an NFT that secures the right to use or develop a plot of land in a “virtual environment” would not be a §408(m) collectible because a right to use or develop a plot of land is not a §408(m) collectible.
The notice asks five different questions, including if its definition of an NFT is accurate, and requests feedback submitted in writing on or before June 19, 2023.
Taxpayers that have gains in two or more of the three capital gain buckets will need to work through a complex netting process. According to Notice 97-59, capital gains and losses are:
- First netted within each group. Then:
- Short-term capital losses are applied first to reduce short-term capital gains.
- A net short-term capital loss is then applied to reduce any long-term capital gains in the 28% bucket, then the 25% bucket, and then the 0/15/20% bucket.
- Long-term capital losses from the 28% bucket are first used to reduce long-term capital gains from the 25% bucket, and then the 20% bucket. A net loss from the 20% bucket is first used to reduce gain from the 28% bucket and then the 25% group.
- Short-term capital losses are applied first to reduce short-term capital gains.
Net capital losses can only offset up to $3,000 per year of ordinary income. FORVIS intends to remain current with IRS guidance on this topic. To discuss how this may impact your specific scenario, please reach out to a professional at FORVIS or use the Contact Us form below.
- 1“NFT Charts: Transactions, Users and Trading Volumes,” theblock.co