News theme: IRS Floats New Guidance Around NFT Classification That Would Increase Taxes - Blockworks   

• Currently,  NFTs are digital assets that can be bought, sold, and owned like traditional assets such as stocks, bonds, and real estate.

• Generally speaking, short- and long-term capital gains rules and rates of 10%-37% apply. NFTs are taxed like other forms of cryptocurrency - as property, subject to the corresponding capital gains schedules.

• The IRS is considering changing NFTs to collectibles, which are taxed differently from traditional assets.

• Net capital gains tax on collectibles can be as high as 28% for high earners, compared to 15-20% for securities and other goods.

• To determine whether an NFT is a collectible, the IRS uses a "look-through analysis" to examine the associated right or asset and classify it accordingly.

• "Look-through analysis" is a tax classification method used by the Internal Revenue Service (IRS) to determine how to tax certain assets that are held within another asset. In the context of NFTs, the IRS has suggested that NFTs could be classified as collectibles if the associated right or asset is a collectible. This means that the IRS would look through the NFT to determine the underlying asset or right that it represents and tax it accordingly based on the tax classification of that underlying asset or right. For example, if an NFT represents ownership of a stamp, and stamps are classified as collectibles under US tax code, then the NFT would also be classified as a collectible and taxed accordingly. The look-through analysis is aimed at ensuring that NFTs are taxed at the correct rate and according to the correct classification on an investor's tax return.

• The IRS and Treasury are currently accepting public comments on NFT tax guidance, with official guidance expected to be issued after June 19, 2023.

The recent notice from the Department of the Treasury and IRS proposing higher tax rates for most NFTs classified as collectibles can have significant implications for the NFT market and its participants. Here are some potential impacts:

• Decreased demand: Higher tax rates may discourage potential buyers from purchasing NFTs, leading to decreased demand in the market. This can lead to lower prices and decreased liquidity.

• Increased complexity: NFT taxes can be complex, especially for those who are not familiar with tax laws or NFTs. This can make it more difficult for NFT creators and traders to navigate the market, and potentially lead to decreased participation.

• Uncertainty and volatility: Uncertainty around NFT tax regulations and potential changes can create volatility in the market. This can lead to price swings and fluctuations, making it difficult for traders to accurately assess the value of their holdings.

• Appraisal challenges: Appraising the value of NFTs can be difficult, especially when they are first created. The proposed tax regulations may require NFT creators to seek out professional appraisers to determine the fair market value of their assets, which can be costly and time-consuming.

• Potential for innovation: The proposed tax regulations may encourage NFT creators and traders to develop new models and structures to minimize their tax liabilities. This can lead to innovation in the NFT market, potentially creating new opportunities and revenue streams.

Overall, the proposed tax regulations may have both positive and negative impacts on the NFT market and its participants. It remains to be seen how the market will adapt and evolve in response to these changes.

Examples:

• You purchased a CloneX avatar for 3 ETH when ETH was $4,000 (for a total purchase price of $12,000).

• You later sold it for 4 ETH when ETH was $4,500 (for a total sales price of $18,000).

• You recognized a taxable gain of $6,000.

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