What Are NFTs and How Are They Taxed?

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If you could pick out a few buzzwords about cryptocurrency in 2021, NFTs, DOGE, SHIB and Ethereum are probably some of the big ones you can think of.  Whilst NFTs have been around since 2015, sales and interest have skyrocketed since February 2021.  Since that’s why you’re probably here, let’s jump in so you can learn all about what NFTs are and how NFTs are taxed in Australia.

What is an NFT?

NFTs, or Non-Fungible Tokens are digital assets that are used to represent real-world objects such as art, music, videos, in-game items and more.  They are usually purchased or sold online using cryptocurrency and are transacted and encoded through the use of blockchains .

NFTs are particularly popular at the moment because they are inherently designed to create digital scarcity. Whilst it might be possible to create a convincing forgery of a physical artwork, or simply copy-paste and image online, by existing and being encoded on a blockchain, the code identifier for each NFT is inherently unique and verifiable by anyone.  Even in the case of multiple instances of a non-fungible token being created (think of it like limited numbers of prints of an artwork), each has a separate unique identifier as part of the limited run.

So, the price for NFTs is often high because there’s a limited supply – that’s typical supply and demand at work – so why are people so interested in them at the moment?  Much of the current volume of non-fungible tokens in 2021 is a result of existing real-world or digital items being given a digital ownership license in the form of an NFT.  Even Disney jumped on the NFT train, selling limited edition pieces of digital art based on its properties such as Marvel, and The Simpsons on Disney+ Day for $60 USD each.  People are now reselling these upwards of 10 times what they originally paid for them in some cases.

Ok, so I can stand to make a bunch of money, but why would anyone want to buy something that can be viewed online for free?  Bragging rights mostly – for many it’s like a limited-edition collector’s item.  Whilst the market is still evolving for how NFTs are used and regulated, NFTs can already be used to receive royalties for the distribution and use of the item.

Fungible vs Non-Fungible Tokens

Fungible tokens are your typical cryptocurrencies which are traded, generated and interacted with on the blockchain, such as Bitcoin, Ethereum, Doge and more.  For an item to be fungible, like cryptocurrency or regular fiat currency, all tokens must be the same, this allows each token to be exchanged or traded for each other, and the value remains constant relative to itself ($1 AUD always equals $1 AUD; 1 BTC always equals 1 BTC).

Ok, but what are non-fungible tokens? Non-fungible tokens are different in the sense that no item is exactly the same or has the same value.  A Simpsons NFT isn’t valued the same as an NBA NFT, and even when limited runs of the same NFT are produced, number 1/50 may have a greater value than number 32/50.  Each digital signature is different and to buy or sell one requires using a fungible token such as Ethereum.

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So how is an NFT different from cryptocurrency?

Whilst non-fungible tokens and cryptocurrency are both derived from similar programming and housed on the blockchain, this is where their similarities end.  As cryptocurrency is a fungible currency, it’s used to perform transactions on the blockchain.  As NFTs are non-fungible, they are more like assets that you purchase with cryptocurrency.  (Note that for tax purposes, cryptocurrencies are generally classified as assets which you can read more about here.)

How does an NFT work?

Non-fungible tokens are housed on blockchains such as Ethereum, or Solana.  Blockchains are distributed public ledgers that record transactions such as the movement of cryptocurrencies.  When an NFT is “minted” the unique digital identifier is assigned to represent either a tangible or intangible item such as:

  • Art,
  • Video,
  • Music,
  • Video game assets,
  • Recordings,
  • Collectibles,
  • GIFS,
  • Tweets,
  • Etc.

The NFT is a digital file which can be held in a digital wallet such as Metamask and can only be held by one person at a time.  The unique identifier allows for the easy verification of ownership and transfer of ownership through the blockchain.  When non-fungible tokens are minted, the creator can also store specific information inside such as an authentication signature for artwork.

What are NFTs used for?

NFTs are particularly useful for artists and other content creators to monetise their work.  When they mint the non-fungible token for a piece of digital art for example, they can program in the royalties they automatically receive (as cryptocurrency) when they sell the art or license it out for distribution.  It also allows them to bypass middlemen in the sales process such as galleries or auction houses, and sell directly to consumers on marketplaces like OpenSea, allowing the artist to keep more of the profits as well as royalties on each sale on the secondary market.

Non-fungible tokens have also been used by big brands and companies to auction off art and raise money for charity, explore new revenue streams and more.  Celebrities, and everyday people have jumped on the train to sell unique memories, artwork, moments, GIFs and more.

Should you buy NFTs?

In general, most NFTs are entirely defined by how much someone is willing to pay for it.  Whilst NFTs are not fungible, like cryptocurrency, they share much of the same risks such as:

  • External global market forces reducing interest in the crypto market
  • Cryptocurrency regulation
  • Reduced demand
  • Tax implications

When deciding to purchase non-fungible tokens, you should approach it like any investment decision and do your research, understand the risks and know there’s the possibility of losing your investment.  So it’s always best to approach these decisions with caution if you’re investing larger sums of money.

How are NFTs Taxed?

How NFTs are taxed in Australia

In Australia, the ATO has provided broad guidelines on the tax treatment of NFTs depending on their use case. Depending on how you are using NFTs you can pay tax according the the method that best suits your use case:

  • under the capital gains tax (CGT) regime
  • on revenue account as trading stock
  • as part of a business or profit-making scheme
  • or depending on the terms of the NFT smart contract and the rights it grants, a combination of the above.

In general for most users who are buying or selling NFTs, you will treat NFTs in the same manner as normal cryptocurrency as they fall under the same rules for Crypto assets and Capital Gains.  The following actions with NFTs are considered disposals and will trigger CGT events:

  • Selling NFT’s in exchange for cryptocurrency
  • Exchanging one NFT for another NFT or fungible cryptocurrency
  • Giving a NFT as a gift (unless it is to a tax deductible entity such as an Australian charity)

The minting of an NFT is generally not a taxable event.  It’s only the disposal of the non-fungible token (such as through sale, trade or bridging) that constitutes a CGT event.  The exception is when the value of the asset the NFT is minted for increases since the original purchase, which would constitute a CGT event.

Check out the blog Crypto Tax Australia: Crypto Capital Gains & Obligations for more information about Capital Gains and cryptocurrency.

Business implications of Non-Fungible Tokens

Non-fungible tokens can be used to represent a smart contract which is sold from a business and another party. Smart contracts are programs or transaction protocols which automatically execute, control or document legal events and/or actions as outlined in the terms of the contract or an agreement.

When the sale of the NFT results in income to the business, such as the original sale, or commissions from resale, these profits are treated as business income for tax purposes.

If the original business closes and yet some party continues to receive revenue on transfer of the NFT, the party’s income will be assessed as ordinary income.

Whilst we mentioned earlier that minting NFTs is usually a non-taxable event, if you are an artist generating NFTs to sell with your art, they may be considered as a business operation. The minting of the NFT could then potentially be treated as business income and applicable for tax. In this case, it would be best to speak to an accountant to discuss your tax obligations.

Can NFTs be used for Personal Use or Capital Assets?

This depends on how the NFT is used, for example, if a private viewing of the NFT at a family event occurred – this would be personal use.  However if people were charged to view the NFT, such as in an art gallery, this would be treated as a capital asset for the business, with the proceeds treated as business income.

Bridging NFTs

When you move a non-fungible token between different blockchains such as Ethereum and Solana, this is called bridging.  The ATO guidelines here treat bridging as a change of the rights of the NFT, and would therefore be a CGT event.  This is particularly true when someone might choose to move the NFT to a different network where the NFT may appreciate in value at a higher rate than the original blockchain.

Wrapping NFTs through tools such as Wormhole to transfer them between blockchains is also treated in the same way as it changes the rights of the NFT, resulting in a CGT event.

What are NFTs

Staking NFTs

When you choose to stake a network, you lock up a certain amount of cryptocurrency to support the ongoing operation and security of the blockchain.  Depending on the network, you can receive payments based on the value of your staking amount.  These payments are not treated as CGT events by the ATO and instead as regular income (which would incur their own CGT event when sold).  If you ever decided to sell the cryptocurrency you were using to stake the blockchain, you would only pay CGT on this.

Whilst the ATO hasn’t defined specific guidelines for NFT staking, given that its non-fungible token guidelines are very similar to that of traditional cryptocurrency, it is likely that NFT Staking will be treated in the same manner.

Wrapping NFTs through tools such as Wormhole to transfer them between blockchains is also treated in the same way as it changes the rights of the NFT, resulting in a CGT event.

Gaming NFTs

One of the newest developments in the video game industry is the use of NFTs to support cross-game and cross-platform persistence of in-game items such as skins, characters, weapons, etc.  In supported games, players can create, trade or earn NFTs and associate them with a player licence.  There are a multitude of uses for gaming NFTs, which you can read more about on the CryptoTaxCalculator Website.

Given how new this type of use for non-fungible tokens is, the tax guidelines are not fully defined as of yet. It is best to ask your accountant for guidance, particularly if you are engaging in high-value transactions. Like any investment, it’s best to be conservative and evaluate all the risks involved.  Based on the ATO’s general guidelines for cryptocurrency and non-fungible tokens, the following taxable events are likely for gaming NFTs:

  • Creators of any NFT items may be required to pay income tax on any digital sales or transactions
  • Buyers of NFT items may owe capital gains tax on cryptocurrency that is exchanged for the items (if the cryptocurrency used doesn’t fall under the personal use clause)
  • If NFT items are traded for a profit, a CGT event could be triggered
  • Additional implications may occur if a recurring revenue stream results from NFT gaming or if NFT trade becomes a regular income source
  • NFT users should be cautious as misplacement of NFT items may not qualify you for a tax claim under investment or gambling loss.

Expert Crypto Tax Reporting & Tax Returns

With how rapidly the cryptocurrency landscape is evolving, it’s always best to consult the experts to make sure you stay on the right side of the ATO.  With POP Business you can be sure your cryptocurrency and NFTs are reported correctly on your tax return every time.  POP Business uses CryptoTaxCalculator to help sort out your crypto tax nightmare. Why CryptoTaxCalculator? They are Australia’s leading crypto tax reporting platform, integrating directly with major exchanges and blockchains and liaising with the ATO to quickly and easily identify, categorise and reconcile cryptocurrency transactions.  Follow the links or call 1300 180 630 to get started.

The information provided in this article is general in nature and is not tax, accounting or legal advice. It has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider the appropriateness of the information having regard to your own objectives, financial situation and needs and seek the professional advice of an accountant or qualified financial advisor.

POP PTY LTD (POP Business & POP Tax) and CryptoTaxCalculator disclaims all and any guarantees, undertakings and warranties, expressed or implied, and is not liable for any loss or damage whatsoever (including human or computer error, negligent or otherwise, or incidental or Consequential Loss or damage) arising out of, or in connection with, any use or reliance on the information or advice in this article. The user must accept sole responsibility associated with the use of the material on this site, irrespective of the purpose for which such use or results are applied. The information on this website is no substitute for specialist advice.

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As a solution-focused CIO and ITC strategy consultant with over 15 years’ experience in the IT leadership, enterprise strategy delivery, program management, digital transformation, and software development space, I have led the delivery of strategically aligned solutions capable of solving customer problems in disruptive digital environments. I offer expertise in Software Development, Mobile App Development, Business Process Automation, Agile program delivery, SaaS product development, and team leadership. I have expertise aligning enterprise strategies with operational IT delivery, enabling large ITC teams to deliver simple, memorable customer experiences. I offer a unique combination of strategic insight, analytical ability, innovative problem-solving approaches, and a precise attention to detail to deliver sustainable results in fast-paced environments.

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