NFTs and Tax
NFTs and tax!
Words: Jacqueline Hodges
Australian Tax Law is complicated, it changes every day. It changes through legislation, taxation rulings, court cases, and then there’s The Commissioner of Taxation Powers. Let’s face it the Australian tax system is greedy, the ATO want your money, and for good cause. Our taxes go towards, our health system, our roads, our education, our poor, and many more public services. So it should come as no surprise that Treasury decided to tax the income you make for your Non Fungible Tokens NFTs. So, let’s have a look at NFTs and tax!
Whether you are investing, trading, received a gift, or just dabbling in this market then there is a tax consequence. If you’ve made a gain, a loss, or broke even you may have to disclose that in your tax return. In Australia, as with many nations around the world, NFTs represent an ownership interest in any tangible or intangible asset, even where you store the asset outside of a digital ledger.
So, your sales and disposals are taxable property transactions. In Australia, the sale of property at a profit is a capital gain and the sale of property at a loss is a capital loss. These capital gains and losses are usually included in your tax return.
To help you understand how the tax applies to your NFT, we have included a few examples of the common transactions and events that you will encounter when buying and selling NFTs.
First the Exception
Australian tax law is complex and even though the general rule is your NFT is taxable, there is an exception for personal use. Even this exception is a little complication. If you have purchased or received an NFT and you nave an intention of making a profit, or holding it as a long term investment, then you own taxable property. However, if you only have a right to view an NFT artwork for a few hours and you and a few friends enjoy the art viewing at a private party, then it is probably a personal use asset and exempt from tax. Likewise if you acquired a personal use asset for less than $10,000, a capital gain made at the time of disposal is exempt from tax.
Example: Personal Use Asset
Starr, a professional artist, is known for her Alice in Wonderland painting. She is excited by one painting in particular and decides to create five NFTs. Each NFT provides the right to one, four-hour, exclusive viewing of the portrait in a private viewing room in Starr’s private gallery each year for up to 20 people.
On subsequent transfers of the NFTs to new owners, the smart contract allocates part of the proceeds to Kim as a commission. Kim retains all other rights associated with the painting. The proceeds of the initial sale would be assessable as business income to Kim and any commissions received are assessable as ordinary income to Kim.
The tax treatment for the owners of the NFT right depends on how they made use of the NFT.
Constance owns one of the NFT rights and she uses the private viewing of the portrait to celebrate their birthday with close family and friends every year.
Constance’s NFT is a personal use asset.
Similarly, to cryptocurrency the longer you hold the NFT the less likely the ATO will treat the holding as a personal use asset. Also if Constance’s party was an event and she charged an admission fee, then the NFT would be a capital asset and the admission fees would be business income.
Example: Not a Personal Use Asset
Miranda buys an NFT horse in an online game for $100 of cryptocurrency. The virtual horse has its own “DNA” and owners can race, breed, and build up their own stable or they may sell their NFT horse. Miranda races her horse and finds it has excellent prospects.
She decides to breed her horse, to keep some of the “offspring” to build up her stable and to sell some of the offspring to fund her racing. Even though Miranda has spent less than $10,000, she had an intention to make a gain. It is unlikely, the ATO will view either the original NFT horse or its “progeny” as a personal use asset.
Now for a Word on Tax
Capital gains tax rules apply when you dispose of your NFTs. A disposal can occur when you:
- sell your NFT in exchange for cryptocurrency
- trade or exchange your NFT for another NFT, or
- gifting your NFT.
Note also that there will be tax events associated with the cryptocurrency transactions linked to any NFT transactions.
Bridging
Bridging allows owners to move their NFT assets between different blockchains. This may be seen as a taxable transaction by the ATO. According to the ATO if you are changing the rights of the NFT by bridging from one chain to another, this is a capital gains tax event. If you are wrapping an NFT to generate income may also be a capital gains tax event. The income generated will be ordinary assessable income.
Example: Bridging
Alice is an Ethereum NFT collector and has a single digital wallet. She purchase an NFT on Solana for $800 and wants to bring it over to her Ethereum wallet. At the time of transfer the NFT is worth $890.00
As the NFT is less than $10,000, Alice will need to consider whether it is a personal use asset. If Alice purchased the NFT as an investment to make a profit in the future, she may have to include the $90 gain in her next income tax return.
Gifting NFTs
Buying NFts and gifting it to you friends, family or a charity is treated as a disposal and is a capital gains tax event for the person gifting their holding. Whether you make a capital gain or a capital loss the amount is recorded in your tax return.
The person who receives the NFT does not pay tax when they receive the gift. But they do need to record the date and market value of the gift at the time it is received. If you gift to a registered charity that is a registered Deductible Gift Recipient you may also be entitled to a tax deduction.
Example: Gifting Your NFT
Marcus wants to surprise Cleo and buys her Blue Oyster an NFT horse her birthday. Blue Oyster has a market value of $18,000 at the time Marcus gives the NFT to Cleo.
Marcus bought Blue Oyster fro $100 when the game first started in 2018 and has made a significant capital gain. He will include the gain in his tax return and pay tax on the capital gain.
Cleo does not record the gift in her tax return. However, 6 months later Cleo decides to donate Blue Oyster to an Arts charity. When Cleo donates NFT it has a market value of $20,000. Cleo makes a capital gain of $2,000 on the disposal and will include the capital gain in her tax return. She may be able to claim a tax deduction for the donation depending on whether the charity is a registered DGR.
Loss or theft of NFT
Have you lost your private key? This is a problem, as a private key can never replaced. If you lose your private key or your NFT is hacked and stolen, you may be able to claim a capital loss in your tax return. Note a capital loss can only be offset against a capital gain. You will need records to show the ATO that you actually owned the NFT. The following evidence and records should suffice:
- the date you acquired the private key
- the date you lost the private key
- the wallet address that the private key relates to
- the cost you incurred to acquire the lost or stolen NFT and cryptocurrency
- the value of your NFT at the time you lost the private key
- the amount of cryptocurrency in the wallet at the time you lost the private key
- the cryptocurrencies and NFTs in your wallet at the time you lost the private key
- the transactions linked to your personal identity showing that you control the wallet
- that you are in possession of the hardware that stores the wallet
- the transactions from a verified account on a digital exchange platform to the wallet
Record Keeping
Anyone dealing with cryptocurrency needs to keep the following records:
- The date of each transaction
- The amount in Australian dollars at the time of the transaction
- Details of the transaction,
- Any associated expenses, like fees and commissions, and
- Details of the other party
- receipts of purchase or transfer of cryptocurrency
- exchange records
- records of agent, accountant and legal costs
- digital wallet records and keys
- software costs related to managing your tax affairs
You will still need these records, even if you believe your holding should be an exempt personal use asset. You will need to prove to the ATO that you used your NFT for personal use.
So, whether you are an early adapter who started buying NFTs in the early days of blockchain or you are new to the digital asset market and exploring your investment options you need to expand your knowledge horizon so you can understand how your NFT will be taxed.
Your NFT tax event will typically be coupled with a cryptocurrency event. to find out how your cryptocurrency is taxed, see our companion article: Cryptocurrency and Tax. If you would like to find our more about NFTs, we recommend you read this article by Danielle Marie: Investing in NFTs.
Jacqueline Hodges is a Chartered Accountant, Registered Tax Agent and SMSF Auditor. She is a Financial Adviser and an authorised representative of Wealth Today. She has a wealth of experience having worked in the financial services sector for most of her career. Jacqueline is a firm believer in continuing education and holds a Bachelor of Commerce (UQ), a Master of Taxation (UM), and a Financial Planning Certificate. She established her own accounting firm servicing individuals and small businesses in 2005 and complemented the business in 2015 with the opening of the financial advice division.
Disclaimer: The information contained in this article is general in nature and may not be relevant to your personal circumstance and needs. Taxation, legal and other matters referred to in this article are of a general nature only and are based on laws existing at the time and should not be relied upon in place of appropriate professional advice. The examples provided do not cover all Non Fungible Token or cryptocurrency events.
We recommend that you assess whether the information is appropriate to your needs and if appropriate speak with a financial adviser to discuss your needs, financial situation and investment objectives.
HQ Wealth Pty Ltd as trustee for HQ Wealth (CAR 1238791) and Jacqueline Hodges (AR 1238790) are Authorised Representatives of Wealth Today Pty Ltd (ABN 62 133 393 263), AFSL 340289.
Jacqueline Hodges, 10 Ellen Media
This article is republished from WFO. Read the original article.
