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New IRS NFT Rules – Episode 361

Adam Talks

In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses changes the IRS made to the Form 1040 regarding digital assets, including NFTs, and what that may mean for retirement investors.

Breaking News: New IRS Rules on NFTs (Non-fungible Tokens)

Hey everyone., Welcome to another episode of Adam Talks. I’m Adam Bergman, tax attorney and founder of IRA Financial. On today’s podcast, going to be discussing new IRS tax language, including NFTs as digital assets. What’s the implications of this? How does this impact you personally, filing a 1040 tax return? And does this change the definition of an NFT for Self-Directed IRA purposes? A lot of details to unpack and this is going to be a fun podcast, so buckle up and let’s get started.

So, basically what happened is the IRS finally announces some guidance on the 2022 instructions for filing the 1040 next year. You file the 2022 tax return in 2023. So, what they wanted to do, clearly, is expand the definition of virtual currency, right? Last year in the 1040, you have to disclose if you’ve invested in virtual currency, right? The IRS wants information on whether you’ve personally owned cryptocurrencies, okay? And this is something that kind of just started the last few years. And this is what it says on the 2021 taxable year; it’s like the 6th row down. “At any time during ’21, did you receive, sell, exchange or otherwise dispose of any financial interest in any virtual currency?” And it’s a yes and no. If you use yes, guess what? The IRS is going to be interested to find out if you reported any of the potential capital gains on your return – short-term or long-term.

So, this is something that the IRS is been zeroing in on, and they know there’s definitely lack of compliance on the part of taxpayers and they’re certainly more focused. So that’s been in place; so now what they’ve done for the next year, for the 2022 taxable year, is they said, okay, that old definition of virtual currency, great. But guess what? We’re going to add new language and we’re going to take a broader view on digital assets and we’re going to include an explicit recognition of NFTs.

So, what they’ve done is before, in the past, people said, well, it’s unclear if an NFT is a virtual currency. Maybe it’s collectible, maybe it’s nothing, right? What is it? No one knows, okay? So, some people, I assume, didn’t report any gains from NFT sales or even on the 1040 that they’ve invested in NFTs. So, what the IRS wanted to do is say, you know what, let’s stop all this. If you own digital assets, including NFTs and cryptos or any other types of digital assets, you got to now include it; and they said digital assets includes NFTs and virtual currencies, such as cryptos and stablecoins, okay? So, they’ve expanded the definition of digital assets. That was primarily done for tax return Form 1040, the individual return, because the IRS wants more information on whether people are buying and selling NFTs and making sure that if there’s gains on those NFTs, that you are reporting them and paying tax.

But, indirectly what they’ve also done, is they’ve expand the definition of virtual currency to include NFTs, so now, the idea is this: if you are investing in NFTs with an IRA or 401(k); before this announcement, there was a lack of clarity, is it a collectible? What is it? What is an NFT? We know it’s a non-fungible token. We know it’s not tangible; it’s intangible. We know it could be a utility-type token, right? Like a reward token. It also could be just a piece of art, a digital logo, digital representation, something digital, piece of art, digital highlight, right? It was super broad in terms of what the potential is.

So, a lot of people took the position, well, until the IRS offers some clarity on this, I’m not going to use my retirement account, my Self-Directed IRA or my Solo 401(k) to invest in NFTs, because I’m not sure if they’re going to treat as a collectible. And why is that important? Because section 408(m) of the Internal Revenue Code states specifically that retirement accounts may not purchase collectibles, and then they list what a collectible is, essentially like art, stamps, and basically say any other tangible asset that is determined by Treasury.

Now, interesting, they use the word tangible and not intangible. So, some people then said, well, we know an NFT is intangible, so it’s unlikely that the IRS can add that NFT to the description of other collectibles, like art. However, we know if the IRS wants to prevent you to do something, they don’t have to necessarily put in the Code. There’s ways to do it like rulings or procedures, req procs, revenue rulings, letter notices, things like that, where they can get their point across or through case law to make it clear that this is their position. So, now what has happened is, if you look at the definition on the 1040 return, they’ve used a broader-based language for digital assets which explicitly includes NFTs. So, if you look at 2014-21, which is the notice that talks about the fact that virtual currency should be treated as property like stocks or real estate, they mentioned the word digital only a few times, right? Mostly they use the term virtual currency in 2014-21, when they use the term digital, they talk about virtual currency is a digital representation of value, okay? So, they’re using the word virtual currency, but they also acknowledge that it’s a digital representation of value. But what this new announcement has done is it said, okay, in the previous years we used the definition of virtual currency, but now we’re going to expand it to include digital assets like NFTs. So, taking that thought process, if they’re going to treat NFTs like digital assets, which is like virtual currency, an expanded definition of virtual currency, so should we take the position, can we take the position that now the IRS says, hey, NFTs are not collectibles, they should be treated as digital assets, right? Because if an NFT is a collectible, you probably wouldn’t have to report it as part of your digital asset or virtual currency purchase. You would treat it as a collectible. That’s one side, right?

The other side could say, hey, yeah, they’re still treated as a digital asset, but it’s a digital collectible. I don’t know, still gray, but we have more support now for the position that NFTs could be treated as virtual currency and thus, be treated as a digital asset under the expanded definition as per the new 1040 instructions. And therefore since an IRA and a 401(k) is allowed to buy virtual currency by way of 2014-21, they should also be allowed to buy NFTs, because the definition of virtual currency has now been expanded to be defined as digital assets, which explicitly includes NFT.

So, if you take the backdoor in and say, okay, IRS is treating NFTs like a digital asset, which is a broader type of virtual currency, and they’re treating them as one, then an IRA, since it’s allowed to buy a virtual currency, should be allowed to buy an NFT since it’s a representation of a digital asset and it’s not a collectible. I think there’s stronger support today than there was a month ago, okay? It’s still potentially gray because the IRS could always come back and say, well yeah, we use that definition for the personal tax return 1040 purposes, but from a retirement account standpoint, we still want to treat as collectible. We don’t want IRAs or 401(k)s investing in it. That’s possible.

But right now, I think you have a stronger argument if you really want to buy NFTs in your IRA or 401(k) to say, hey, it’s a virtual currency; you, the IRS, are treated it as a virtual currency, by way of your announcement and your new expanded definition of digital assets on form 1040, therefore, since you’re treating NFTs as a digital asset, we know IRAs and 401(k)s can buy digital assets and virtual currency by way of 2014-21. Hence, my IRA of 401(k) should be allowed to buy NFTs because it’s a digital asset and not a collectible. And that would be the argument I made.

Again, there’s no confirmation on the IRS that they won’t come up with any type of announcement on collectibles, NFTs and retirement accounts, but I wouldn’t hold my breath on anything soon. 2014-21, that’s eight years ago, right? The only reason they made this announcement is they have to come up with new rules for the 1040 for next year. So, they had to stick it in there because they are worried that even though the NFT markets tanked in 2022, they expect it to essentially rebound, eventually will rebound, right? Just like cryptos ultimately will eventually go up. The NFT market is not going to go away.

So, they want to make sure they’re capturing the taxable income from NFTs because that’s an additional stream of tax revenue, since an NFT would be treated as a digital asset, a capital asset as per 2014-21, it’s subject to the capital tax regime. Short term capital gains if held for less than twelve months, long term capital gains if held greater than twelve months. So, that is a stream that, a revenue stream that they do not want to give up and they want to make sure they capture.

So, that’s kind of the bad news for individuals, but for retirement accounts, I think this is really good news, this announcement, because it expands the definition of digital assets to include NFTs, and an argument could more easily be made today than several weeks ago that an NFT is a digital asset and not a collectible, since the IRS treats it as such for individual income tax purposes.

So, hope you guys enjoyed today’s podcast. This is a lot of fun. I love kind of taking IRS announcements and finding a way to use the value in those announcements to help retirement account investors. Sometimes it works, sometimes it doesn’t. I think in this case there’s much, much stronger arguments to be made that an NFT should be deemed a digital asset and not a collectible. Again, the IRS could come in and say, yeah, it is a digital asset, but it’s a digital collectible. Although 408(m) of the tax code generally focuses on tangible assets as collectibles, not intangible, although that section was written 30 years ago, so I don’t think anyone had any type of expectation that NFTs and virtual currency would become a thing. So, the IRS could always come up with further guidance on NFTs and collectibles or whether it should be a virtual currency/digital asset, but I don’t expect any announcement anytime in the next few years; that’s going to be way down the road. So, I think for now, there is some good support to take the position that an NFT is a digital asset that could be permitted in retirement account and not a collectible, but we shall see.

But anyways, I appreciate you guys spending some time with me today. Really, really an interesting topic that was just announced by the IRS and I think could help retirement account holders. So, have a great day, appreciate you guys listening, and again, this podcast drops every Wednesday, so make sure you check it out next week. Be well, take care and have an amazing day.


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