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Will your NFT trades result in an income tax audit?

On Behalf of | Mar 11, 2022 | Tax Law |

Digital assets are more popular than ever, and more easily accessible than they were just a few years ago. More people have begun to buy them as unique property and as potential investments. While some people invest in digital currency, others invest in unique digital assets.

Non-fungible tokens (NFTs) are unique digital creations that people purchase as collectibles or personal investments. Examples of NFTs range from limited-edition digital prints of original works of art to unique self-portrait photographs taken by celebrities. People and businesses alike have sold everything from screenshots of their most popular social media posts to digital paintings as NFTs.

If you have begun to dabble in NFTs, you may feel excited about the opportunity they represent. You may have even made money off of NFT transactions. Now that you need to file your annual income tax return, you find yourself worrying about that money. Will the sale of NFTs put you at risk of a tax audit?

You have to report and pay tax on NFT sales

There is not an immediate cause for alarm if you have made money from NFT-based transactions. Having NFTs in your portfolio or making money off of them doesn’t immediately mean you will face an audit or punitive actions by the Internal Revenue Service (IRS).

Provided that you report the income made from those transactions and pay the appropriate amount of tax, someone with revenue generated by NFTs won’t be at higher risk of an audit than any other individual with investment income. However, doing so isn’t exactly easy. The IRS has not yet published official guidance, so people are unsure of how they may qualify NFT income.

It may be better to err on the side of caution and pay more than you owe instead of underpaying. Some professionals suggest that you assume that the tax rate that applies to NFT sales will be one of the highest, as the IRS could categorize them as collectibles.

What if you haven’t paid taxes on NFTs?

The IRS is only begun to clarify its stance on digital assets. While the IRS has actively pursued those not paying tax on cryptocurrency transactions for several years, reporting and paying tax on NFTs is still relatively new, especially given the lack of formal guidance.

Reporting and paying taxes on current transactions helps keep you in compliance once the policy is announced. If you need to amend a prior year’s tax return, doing so before the IRS notices the discrepancy may reduce your risk of an audit or punitive actions because of those previous tax mistakes. Learning more about changing tax rules can help you prevent or prepare for a potential audit.

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