On March 21, 2023, the Treasury Department and the Internal Revenue Service (the “IRS”) announced that they were requesting comments regarding upcoming guidance on US tax treatment of certain nonfungible tokens (“NFTs”) as collectibles under Internal Revenue Code (IRC) section 408(m).
An NFT is a unique digital identifier that is used to certify ownership and authenticity of either a right
with respect to a digital file (e.g., a digital image) or a right with respect to an asset that is not a digital file (e.g., a right to attend a sporting event) – i.e., an associated right or asset. It is recorded in a blockchain using distributed ledger technology and cannot be copied, substituted, or subdivided. Unlike cryptocurrencies, which are fungible, NFTs are uniquely identifiable assets. The ownership of an NFT can be transferred by the owner; as a result, NFTs can be sold and traded.
Distributed ledger technology is a digital system for recording, sharing and synchronizing transactions and their details in multiple places at the same time.
IRC section 408(m)
IRC section 408(m)(2) provides a list of items that are treated as collectibles for certain US tax purposes. For example, under IRC section 408(m)(1), an acquisition by an individual retirement account of a collectible is treated as a distribution from such account equal to the cost to the account of the collectible.
The specific list of items that are treated as collectibles under IRC section 408(m)(2) is as follows:
– 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 for purposes of IRC section 408(m)
Pending further guidance, the IRS intents to use a so-called look-through analysis in order to determine whether an NFT constitutes a collectible under IRC section 408(m). Under the look-through analysis, a determination of whether an NFT constitutes a collectible under IRC section 408(m) is made by reference to the list of collectibles included in IRC section 408(m). More specifically, to the extent that the NFT’s associated right or asset is included in the definition of a collectible under IRC section 408(m), the NFT itself is treated as a collectible under IRC section 408(m). For example, a gem is included in the list of items that are treated as collectibles under IRC section 408(m)(2), as referenced above; therefore, an NFT that certifies ownership of a gem should constitute a collectible.
One of the questions that the IRS has raised in applying the look-through analysis is whether a digital file constitutes a “work of art” and therefore an NFT with a digital file as its associated right or asset should be treated as a collectable under section 408(m).
In Notice 2023-27, the Treasury Department and the IRS have requested comments on any aspect of NFTs that may affect the treatment of an NFT as a collectible. In that Notice, among others, the IRS has specifically requested comments as to whether:
- The IRS has accurately defined an NFT;
- There are factors to consider when determining whether an NFT constitutes a collectable under section IRC 408(m); and
- There are burdens associated with the application of the look-through analysis.
The IRS has requested that the comments are submitted in writing on or before June 19, 2023.
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