There is No Place to Hide: Would NFT be Taxable?

NFT stands for non-fungible token. It’s a fancy term for a unique digital asset that is associated with blockchain technology. Regardless of recent ups and downs of cryptocurrencies, businesses relating to NFTs have rapidly expanded. It encompasses both tangible and intangible assets such as music, fine arts, sports, hard jewelry, virtual goods, and so forth. NFTs will likely continue their double digit growth in the coming years despite recent troubles with cryptocurrencies. 

Korea has once taken up almost 30% of global cryptocurrencies and NFTs trades. Perhaps, zero tax on digital assets has propelled the adoption of NFTs. Due to its popularity, National Tax Services (“NTS”) has announced that NFTs would be taxed in the coming years. However, there are yet no clear rules, regulations, and even taxable legal definitions of NFTs or broadly digital assets although the legislators have been working on it. 

NFTs have come into prominence at the global scale as a way for creators to get fair compensation for their creative endeavors. It is also helpful for collectors to access a new type of investment worthy assets with ease. Each NFT comes with a unique ID that will be instrumental for a verifiable transaction history. This information should be traceable and secure as it is stored in the blockchain.  

Selling an NFT with cryptocurrencies, fiat money, other NFTs, or any goods or services is considered a taxable event. Creators who use NFTs to digitize their original work would be interested in monetizing their work by selling the equivalent of their original work. The creators still maintain original authorship to the work, and they may produce and sell other copies. However, the unique digital code assigned to each NFT acts like a proof of ownership. Hence, when an NFT is sold, it is a taxable event. The buyer may also have to pay taxes. 

NFTs are taxable. It should be taxed like other assets. But, the process is not going to be that simple. Until further guidance is announced to NFT transactions, taxpayers must apply existing principles of current tax law to NFT transactions. For example, the Internal Revenue Service (“IRS”) in the United States has increasingly issued specific guidance on the tax treatment of cryptocurrencies in recent years. The IRS has also included NFTs in discussions of broader digital assets. 

Despite the strong interest in NFTs, there is no specific legislative guidance currently available in Korea regarding whether NFTs are taxable or not. If so, what is the fair tax rate and tax base of NFTs for tax purposes? In order to delve into and discuss NFT-related tax issues, the first step would be to establish a sound legal definition of NFTs.
In sum, NFT transactions may be viewed as a transfer of a virtual asset or an investment worthy contract, which is one of the securities, or simply a right to the underlying asset such as  copyright or neighboring rights to copyright. In 2022, the IRS released a draft stating that NFTs would be considered digital assets, similar to cryptocurrencies. If NFTs are sold for profit, it would be considered as Capital Gain or Collectible in the tax definition. There is an additional tax aspect that also needs to be considered for sellers of NFTs that have seen the rise in value in recent years. Works of art in real life, for example, are considered collectibles and are taxable at the higher rate at 28%.

One thing to remember, though, NFTs differ from cryptocurrencies. Hence, taxpayers should not treat NFTs in the same manner as we do with cryptocurrencies. Unlike major cryptocurrencies such as Ethereum, which are fungible, NFTs are not interchangeable with each other. In theory, they cannot be directly exchanged for other currencies, goods, or services. However, a growing number of NFTs are attached to real collectibles, not virtual ones. Oftentimes, they are actively changing hands. NFTs that are attached to hard jewelry or expensive cars, for example, are actively traded in respective vertical NFTs.

Many policymakers think that NFT holders owe taxes. Because cryptocurrencies are not the same as fiat currencies such as dollars. Buying with cryptocurrencies is more like selling a stock to get the money to buy an art piece. When an NFT is purchased with cryptocurrencies, the gain or loss on the cryptocurrencies that are used must be calculated for a tax purpose. They could be taxed as a short-term or long-term capital gain, though.

You will likely have to pay taxes upon the sale of NFTs in the near future. If you’re a creator, it would be taxed as ordinary income. As a subsequent owner of NFTs, they are taxed differently depending on the use case and the length of duration that you have held onto. It is not yet 100% clear if tax authorities classify NFTs as collectibles any time soon. Holders must pay taxes upon purchasing NFTs due to the disposal of their cryptocurrencies. When you purchase NFTs with cryptocurrencies, it will also trigger a taxable event as you will have to pay taxes on any capital gain from your cryptocurrencies trading. If NFTs are eventually classified as a collectible, which is also not impossible, it would be subject to the 28% capital gains rate in the case of the U.S. like other collectible assets such as stamps, artwork, and precious metals.

NFTs are a new type of asset. Current tax law is slow to adapt and does not have provisions specifically related to the tax treatment of NFTs. All tax treatments outlined in various forecasts are yet quite speculative based on existing tax law. If you are investing in NFTs, you must be sure to keep good records of your transactions and seek relevant support from tax professionals with domain expertise. Soon after tax authorities release additional guidance, the taxation of NFTs will become more clear and spread fast. No matter what the law says, proper documentation and evidence of your purchases and sales history would minimize potential tax risks in the near future. 


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