24 April 20234 minute read

Notice 2023-27: May we tax NFTs as collectibles? The IRS poses questions for taxpayers

On March 21, 2023, the IRS issued Notice 2023-27 effectively breaking its silence on the tax treatment of non-fungible tokens (NFTs). NFTs soared in popularity over the last few years and have continued to garner significant interest from stakeholders in the industry and other investors. The Notice provides a potential indication of the IRS’ and Treasury’s position that NFTs may be taxed as collectibles in future guidance, however, multiple questions remain. If NFTs were taxed as collectibles, any gain would be subject to a 28 percent rate, which is higher rate than current capital gains rates. Accordingly, how NFTs are taxed may be of great interest to investors and crypto stakeholders.

Defining an NFT

Notice 2023-27 defines 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.” According to this definition, the IRS views an NFT as having two distinct sides: the digital file and the property or rights that it represents. In essence, the digital file looks through to what right or property the NFT represents, as discussed below. The Notice adds that a “digital file” is not the same as a “digital asset” which may show the IRS and Treasury’s interest in keeping digital assets and NFTs separate for tax purposes.

Applicability of Section 408

The Notice summarizes Section 408(m)(1), which provides for the treatment of collectibles in retirement accounts. Specifically, Section 408(m)(1) provides that the acquisition by an individual retirement account (IRA) of a collectible shall be treated as a distribution from the IRA equal to the cost to the IRA of the collectible. Section 408(m)(1) also provides that the acquisition by an individually directed account under a qualified plan under section 401(a) of a collectible shall be treated as a distribution from the account equal to the cost to the account of the collectible.

Further, the Notice states that under Section 408(m)(2) a collectible is defined as any work of art, any rug or antique, any metal or gem, any stamp or coin, any alcoholic beverage, or any other tangible personal property specified by the Secretary. While these items may provide a clearer picture of a collectible, an NFT does not neatly fit into any of those categories – except potentially works of art, as the Notice seems to point out. However, even in that case, the Notice questions the extent to whether an NFT can constitute a work of art for Section 408(m) purposes.

Look-through analysis

Looking through the digital file to the underlying right seems intuitive, but in a world of digital representations, there may be multiple layers to look through, which may present practical obstacles in ascertaining the true underlying identity of the file for Section 408 purposes (e.g., a work of art). The Notice provides a simple example of an NFT providing ownership of a gem – using the look-through analysis, it would constitute a collectible as the underlying ownership right is over a gem, which is specifically enumerated as a collectible under Section 408(m)(2)(C). However, in another example, an NFT representing ownership of a “plot of land” in a virtual environment would not be a collectible because a plot of land does not constitute a collectible under Section 408(m).

Taxpayer’s role in future guidance

The Notice comes in an unusual format, providing for some legal analysis and a section of detailed questions posed to the public for comment to help Treasury and the IRS determine the path forward in taxing NFTs. For example, the Notice asks for taxpayer comments on the definition of an NFT, whether the look-through approach is appropriate, and if there are any other factors to consider when determining whether an NFT is a collectible. Written and electronic comments are due by June 19, 2023.

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