Non-fungible tokens, or NFTs, have become tremendously popular over the past couple of years. In addition to taking the art world by storm, NFTs are revolutionizing the gaming world, powering immersive (and profitable) new experiences. The catch is that the IRS still considers NFTs taxable, which could lead to a surprise tax bill for many players.
Let's look at NFT games, the most popular NFT games in 2021, and NFT game taxes that players should be aware of to avoid a surprise tax bill.
What Are NFTs?
Non-fungible tokens, or NFTs, are cryptographic tokens that exist on a blockchain. While all Bitcoin tokens are identical and worth the same amount, NFTs are unique with customizable metadata. NFTs are also extensible, meaning that you can combine or modify them under smart contract rules to create new unique tokens.
There are many unique use cases for NFTs:
- The rights to digital artwork, such as Beeple's 5000 Days, can be encoded in an NFT and sold to patrons or investors. In addition, these smart contracts can be updated to pay artists a portion of each sale in the future.
- NFTs can represent real-life items, such as real estate, and track ownership and transactions on the blockchain. For example, NFTs could enable fractional real estate ownership or even power stock market listings.
- NFTs can create unique games with smart contracts that enable "breeding" and other capabilities. For example, two NFTs can be combined by a smart contract to yield a new NFT with characteristics based on the two “parents”.
According to NonFungible.com, NFT sales have reached nearly $900 million from a combination of sports cards, artwork, NFT games, and other assets. For example, CryptoKitties, Cyberpunks, and other collectibles regularly sell for thousands or even millions of dollars, primarily on the Ethereum blockchain using ERC-20 tokens.
What Are NFT Games?
Most traditional games involve players spending a lot of time and effort to earn points, level up characters, or acquire items to complete quests. Unfortunately, many game developers prohibit selling in-game assets and accounts. At the same time, players may be hesitant to buy these assets when game developers control supply.
NFT games combine conventional games with NFT-powered in-game assets, such as skins, characters, weapons, virtual land, and more. Players can create or breed new characters, purchase digital items, or earn new items. In addition, they can trade or sell the items to create an immersive virtual economy and enable play-to-earn abilities.
NFTs enable the creation of unique, programmatically created in-game items rather than developer-designed objects. In addition, players have a "license" that certifies the in-game item's authenticity, ownership, and transferability. These dynamics can help support a robust play-to-earn business model without the drawbacks of traditional games.
Top NFT Games in 2021
There are many different NFT games, and more are coming out each year. That said, a handful of titles have already become extremely popular among both crypto enthusiasts and gamers. While many of the current stock of games focus on trading cards, there are a growing number of more advanced games, such as arcade racing and metaverse games.
Axie Infinity is a Pokemon-like game where players breed and collect NFT-based digital pets, known as Axies. Using blockchain-powered genetics, strengths and weaknesses are passed down to offspring. You can then complete quests or compete against other players to earn Smooth Love Potion (SLP) to breed new Axies.
Gods Unchained is another trading card game that uses NFT tokens and a ranked game mode to enable player-vs-player battles. Players are matched based on their ratings, and they receive experience points for every win against another player. After you move to the next level, you receive a new pack of cards for your collection.
Splinterlands is a trading card game similar to Gods Unchained because you win new cards in quests or battles. After registering for a Steem account, you have to buy your first pack of cards, which may contain rare cards. After that, you can combine identical cards to boost their power or sell them to purchase other cards.
The Sandbox is a gaming metaverse where players can build and trade NFT-powered virtual assets. In a sense, it's a blockchain-powered version of Minecraft or Roblox. In addition to creating items, players can create and play custom games on the platform using the items. While SAND is the native token, LAND has become one of the most sought-after NFTs.
Alien Worlds is the largest decentralized metaverse where you can collect and play with unique digital items. Unlike other trading card games, Alien Worlds NFTs have actual characteristics recognized by the game's smart contracts. For instance, one NFT might yield more Trilium (the in-game currency) or be capable of being used more frequently.
Battle Racer is an arcade racing game where players can mix and match NFT-based parts and weapons to create the perfect racing machine. In addition to competing with other players, you can tokenize your prized car on the blockchain to record your wins and earn exclusive bonuses. Your vehicle can also be sold or traded to other players for income.
NFT Game Taxes
NFT sales have reached nearly $900 million, according to NonFungible.com, but NFT game taxes are ambiguous at best. As a result, players should ask their accountants to provide guidance, particularly if they have high-value transactions, and consider being conservative to avoid potential issues down the road.
NFTs are a potential goldmine for the IRS because they produce multiple tax events:
- NFT creators owe ordinary income tax on any digital sales. For example, NFT gamers who mint a new item and sell it may owe income tax on the sale proceeds. Ordinary income taxes can be upwards of 35%, making these taxes significant for some.
- Buyers owe capital gains tax on the cryptocurrency that they exchange to purchase an NFT. For instance, NFT gamers who buy an item with ETH may owe capital gains tax on the ETH transaction, which can be upwards of 15%.
- NFT gamers that flip an NFT for a profit may owe capital gains or collectibles tax on the transaction. Collectible taxes are typically 28% even if the asset is held for longer than one year (e.g., a long-term capital gain).
That said, the IRS hasn't issued any specific formal or informal guidance on NFT game taxes. NFT gamers may want to take a proactive stance to avoid the need to back pay taxes in the future (as was the case with early cryptocurrency investors). However, you may not be able to claim an investment or gambling loss if you misplace the NFTs.
ZenLedger makes it easy to track crypto transactions, including NFT game taxes, across wallets and exchanges. In addition to aggregating transactions and computing capital gains and losses, the platform autocompletes the IRS forms you need and even integrates with TurboTax. You can also identify ways to save money through tax-loss harvesting.
The Bottom Line
NFT games blend conventional games with blockchain-powered in-game assets, such as skins, characters, or weapons. While these games have innovative in-game economies, there are NFT game taxes that players should carefully consider. Unfortunately, the IRS hasn't provided any specific guidance, but a conservative strategy can help avoid problems.