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NFT Crypto: Use Cases, Platforms & Tax Implications

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May 3, 2021
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    Non-fungible tokens, or NFTs, have soared in popularity. In fact, over the past month, NFT sales topped $200 million with over 145,000 sales, according to NonFungible. Beeple may have captured headlines with his $69 million NFT art sale, but sports leagues, major publishers, and celebrities promise to propel NFTs further into the mainstream. 

    Let’s take a look at the concept of non-fungible tokens, the most common use cases, platforms that facilitate NFTs, and tax implications that buyers and sellers should keep in mind.

    What Is An NFT In The Crypto World?

    NFTs (non-fungible tokens) are tokens, a class of digital assets, that represent ownership of unique but real-world items like digital art, music, in-game items, and videos. Typically bought and sold online via cryptocurrency, NFTs are generally encoded with the same underlying software as many cryptos. It must be noted that an NFT can have only one official owner at a time and they're secured by the Ethereum blockchain. The record of ownership cannot be modified whatsoever.

    Digital artists have been known to lately benefit from the concept of NFTs, thanks to huge sales driven by new crypto-audience. Multiple celebrities have also joined the league as this opens up a new opportunity to connect with fans.

    NFT versus Crypto Coins

    There's often quite a discussion and confusion around the difference between crypto coins or cryptocurrency and non-fungible tokens as they both, after all, belong to the class of digital assets. It must be understood, however, that there lies a clear difference. NFTs or Nonfungible tokens prove ownership of a digital item (digital art, a sound file, or perhaps, gaming items or a video).  An NFT is just built using the same blockchain technology as the currency and that's where the similarities end.

    NFTs are unique, non-identical, vary in value, and cannot be traded or exchanges like cryptocurrencies; making them "non-fungible."

    Common NFT Use Cases

    Non-fungible tokens, or NFTs, are simply unique digital tokens that are stored on a blockchain. Unlike cryptocurrencies, NFTs are unique and provide an extra data layer to encode information (e.g., an image or URL). Since they are stored on the blockchain, anyone can quickly verify their ownership, which is a useful feature in many markets.

    These tokens can represent anything, such as:

    • Jack Dorsey sold his first tweet as an NFT for almost $3 million.
    • Nike was granted a patent to authenticate sneakers using NFTs.
    • The NBA has generated over $230 million selling NFTs of highlight reels.
    • HandShake is decentralizing domains with NFTs.
    • Sorare is an NFT-powered fantasy playing card platform with official club partnerships.

    Most NFT use cases live in the digital realm, but there are signs that NFTs could begin to play an important role in physical asset management. For example, Unistocks sells a $SOCKS token that can be redeemed for a pair of real socks and an NFT representing ownership of that pair of socks, and Sotheby’s and Christie’s have plans to leverage the blockchain.

    In addition to making digital and analog transactions more transparent, NFTs may unlock entirely new business models for creators and consumers. Some NFTs have a built-in feature that pays creators a percentage of each future sale while others provide owners with cash flow derived from the real underlying asset that they represent.

    Where To Buy Non-Fungible Tokens? Popular NFT Platforms

    Most NFTs operate on the Ethereum blockchain, but in reality, they can exist on any blockchain. For example, TRON introduced its NFT protocol in December 2020. The security of the host blockchain is paramount to ensuring that the NFTs are safe, which means that most activity is concentrated on the largest blockchains.

    Download our Checklist of the Most Popular NFTs to identify areas where you could invest in NFT tokens themselves to benefit from upside.

    When it comes to creating NFTs on a blockchain, there are many different platforms that specialize in different areas. SuperRare is designed to help artists monetize their works through NFTs whereas Sorare powers only its own trading cards. The size and popularity of these platforms influences the market for the NFTs that are sold.

    The most popular platforms by all-time volume include:

    Name                              Volume (All Time)                   Sales (All Time)

    CryptoPunks                     $225,025,262                               12,063

    Gods Unchained               $21,737,125                                 567,131

    SuperRare                          $64,961,630                                 21,165

    Sorare                                 $45,561,648                                 265,461

    Art Blocks                          $20,201,472                                 40,947

    Source: NonFungible

    A growing concern among some creators is the carbon footprint of NFTs. Since Ethereum uses a proof-of-work algorithm, each NFT consumes an estimated 200+ kilograms of carbon—equivalent to driving 500 miles in a gas-powered car. Proof-of-stake algorithms will mitigate these problems long-term while some platforms offer carbon offsets in the interim. 

    NFT Tax Implications: Is It Taxed Like Cryptocurrency?

    Yes, non-fungible tokens are subject to a unique set of tax rules. In general, the way that an NFT is taxed depends on the asset that it represents. An NFT that represents real estate will be subject to real estate taxes, whereas an NFT that represents a collectible—such as a piece of art—will be taxed at the collectibles tax rate.

    Don’t forget to download our Checklist of the Most Popular NFTs to identify areas where you could invest in NFT tokens themselves to benefit from upside.

    The biggest tax surprise may come from long-term cryptocurrency holders that purchase an NFT. If you acquired Bitcoin at $1,000 and sold it at $50,000 to purchase an NFT, you would owe capital gains tax on the $49,000 between the purchase and sale price—even though you simply acquired another crypto asset without getting any cash!

    Most NFTs are considered collectibles by the IRS, which means they are taxed at the higher collectible capital gains rate of 28%. Artists or other creators that sell NFTs must also pay ordinary income tax on the proceeds if they are creating NFTs as part of their profession. These tax rates are significantly higher than the long-term capital gains tax rate.

    NFT Crypto
    ZenLedger’s Easy-to-Use Interface. Source: ZenLedger

    The easiest way to comply with the IRS’ complex web of crypto regulations is to use crypto tax software that automatically connects to your accounts and ensures that you’re paying the lowest legal amount possible. For instance, ZenLedger connects with most popular wallets and exchanges, aggregates your transactions, and even pre-fills popular IRS forms.

    Try ZenLedger for free!

    The Bottom Line

    Non-fungible tokens have become extremely popular over the past year. With the number of use cases continuing to expand, there have been hundreds of millions of dollars worth of transactions processed over just the past month. That said, NFT buyers and sellers should be aware of the tax implications of their activities to avoid any IRS troubles.

    ZenLedger makes it easy to aggregate transactions, prepare tax documents and minimize your tax exposure with crypto assets. Try it today for free!

    FAQs

    1) What does non-fungible mean?

    Non-fungible is an economic term used to describe things that are non-interchangeable with other items because they have unique properties and hence, not definitive value. For example, real estate, songs, and art. Fungible items, on the other hand, are items that can be exchanged for/ with other items, owing to their definitive value. For example, money.

    2) How do NFTs work?

    Each and every NFT that exists out there has a unique identifier, is not directly interchangeable with other tokens, each piece has a verifiable owner and they can be bought and sold on any Ethereum-based NFT market. This helps the people who own the tokens because since 'each piece has a verifiable owner,' no one can manipulate an NFT, the ownership can easily be proven and one can even hold it forever, knowing that the digital asset is secured by your wallet on Ethereum.

    3) How do NFTs help the creator?

    On the creator end, again, since these are verifiable tokens, the creator can easily prove that they created it, they can determine the scarcity, can earn royalties every time it's sold, and can also sell it on any NFT market or peer-to-peer. The dependence on a 'platform' to sell, hence, is overruled. For example, if you are a music composer, if you go the traditional way of supplying your music via a platform, let's say Spotify, the majority of profits from sales are retained by the said platform. If you sell your music file on the NFT web, however, you can not only retain the ownership rights but also claim resale royalties directly.
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