Just like with gifts of art, the IRS may decide to treat different people who make gifts of NFTs differently. Creators and dealers may be in a different category from collectors and personal users when it comes to valuation and deductions.
In this environment, a creator is the person or entity who creates the NFT and has it tokenized or minted on the blockchain. A dealer is a person or entity who holds an inventory for sale to consumers. A collector is a subsequent owner who holds the property, although not in the usual course of business, but may have a particular expertise and own several NFTs. A personal user is like a collector in that they are a subsequent owner and are not in the business of selling NFTs, but they are likely more of a one-off type of owner.
For creators and dealers, NFTs will likely be taxed as ordinary assets meaning ordinary gains and losses. For a creator, an NFT is treated like a patent, piece of art, or copyright, because the tax-paying creator used her personal efforts to produce the “thing,” or it was prepared or produced for the taxpayer. The same is true for the dealer of NFTs, because it is held as inventory or for sale to a consumer in the ordinary course of business.
For creators who wish to donate an NFT to charity, the deduction would likely be treated similarly in most cases to that of art, music, or other similar assets. In those cases, the creator is unable to deduct the fair market value of the contribution. Artists are generally permitted to deduct the costs of the materials in the production of the artwork, but not the time or labor in the creation, which would most likely include the costs incurred for tokenizing (or minting) the NFT.
A collector and a personal user, however, is generally treated differently from a creator. NFTs held by these owners would likely be treated instead as capital assets. In this case, an owner can convert the asset into a “long-term” capital asset by holding it for longer than one year. There are however many variables to the taxation treatment of NFTs, as is generally the case with intangible assets. The intent of the taxpayer at the time she acquired the NFT will determine if the NFT is a collectible or a personal asset (meaning, not held for investment purposes).
NFTs that are similar to artwork could also potentially be treated as collectibles. Collectibles have a special treatment in the Code. Even though most capital assets have a top tax rate of 20%, collectibles have a higher maximum rate of 28% even if held for longer than a year. An NFT in certain circumstances may not be a collectible, though, if it contains other characteristics. If the NFT has a physical asset linked to it (e.g., Mintable’s NFT Auction of “Abstract Composition”) or provides some other access or club-like membership experience, aka the Bored Ape Yacht Club, it may instead be classified as subject to regular capital gain tax rates.
Another wrinkle to consider is, if the NFT is treated as a collectible and collectibles are generally treated under the rules for gifts of tangibles – would the NFT then become a tangible asset? And if so, would that gift be subject to the related-use rules? And if so, how would a charity be able to meet the related-use rule? Otherwise, the donor would be limited to the basis for the deduction.
If the artwork resides on the blockchain, “related use” is important to understand. With “normal” artwork – a painting, sculpture, carving, photograph, etc. – a donation to a museum or other institute of art or higher learning was a great way to check the related-use box because the charity could add it to its physical collection, use it as an educational component, etc. These aspects may still be available but could garner additional scrutiny from the taxing authority.