On March 21, 2023, the Internal Revenue Service (the IRS) released Notice 2023-27 (the Notice) announcing that the Treasury Department and the IRS intend to issue guidance related to the treatment of certain Non-Fungible Tokens (NFTs) as collectibles under section 408(m) of the Internal Revenue Code, and requesting comments on such treatment. The Notice provides that until additional guidance is issued, the IRS intends to determine whether an NFT is a collectible by using a “look-through analysis.” Net capital gain from the sale of a collectible generally is subject to a higher tax rate than other capital assets.

Background

According to the Notice, an NFT is 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. Ownership of an NFT may provide the holder a right with respect to a digital file that typically is separate from the NFT, or a right with respect to an asset that is not a digital file, such as a right to attend a ticketed event or to certify ownership of a physical item. For purposes of the Notice, the right that an NFT provides or the ownership of an asset that an NFT certifies is referred to as the NFT’s associated right or asset.

Tax Treatment of Collectibles

Section 408(m)(2) defines “collectible” 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 IRS for this purpose. Section 408(m)(3) provides that certain coins and bullion are excluded from the definition of collectible.

Acquisition of a collectible by an individual retirement account or individually-directed account of a qualified plan is treated as a distribution from the account equal to the cost to the account of the collectible. For all taxpayers, net gain from the sale or exchange of a collectible that is a capital asset held for more than one year generally will be subject to a maximum 28% capital gains tax rate, while an asset that is not a collectible generally is subject to a lower maximum long-term capital gains rate.

Look-Through Analysis

Under the “look-through analysis,” an NFT constitutes a section 408(m) collectible if the NFT’s associated right or asset is a section 408(m) collectible. For example, a gem is a section 408(m) collectible, and therefore an NFT that certifies ownership of a gem constitutes a section 408(m) collectible. In contrast, a right to use or develop a “plot of land” in a virtual environment generally is not a section 408(m) collectible, and therefore, an NFT that provides a right to use or develop the “plot of land” in the virtual environment generally does not constitute a section 408(m) collectible.

The Treasury Department and the IRS are considering the extent to which a digital file may constitute a “work of art” under section 408(m)(2)(A). The Notice clarifies that they currently believe that digital files are not included under any of the categories listed in section 408(m)(2)(B)-(E) – i.e., any rug, antique, metal, gem, stamp, coin, or alcoholic beverage.

Next Steps

The Treasury Department and the IRS are requesting comments on any aspect of NFTs that might affect the treatment of an NFT as a collectible, as well as certain items specifically set forth in the Notice. The IRS will be accepting these comments both electronically and in writing through June 19, 2023.