IRS Provides Guidance on Treatment of Nonfungible Tokens as Collectibles

(Parker Tax Publishing April 2023)

The IRS issued a notice stating that it intends to issue guidance related to the treatment of certain nonfungible tokens (NFTs) as collectibles under Code Sec. 408(m), which is relevant not only to individual retirement accounts and individually directed accounts under a qualified plan, but also for determining applicable long-term capital gains tax rate under Code Sec. 1(h). The notice also describes how the IRS intends to determine whether an NFT constitutes a collectible under Code Sec. 408(m) pending the issuance of that guidance. Notice 2023-27.

Nonfungible Tokens (NFTs)

A nonfungible token (NFT) is a unique digital identifier that is recorded using distributed ledger technology and may be used to certify authenticity and ownership of an associated right or asset. Ownership of an NFT may provide the holder a right with respect to a digital file (such as a digital image, digital music, a digital trading card, or a digital sports moment)1 that typically is separate from the NFT. Alternatively, NFT ownership may provide the holder a right with respect to an asset that is not a digital file, such as a right to attend a ticketed event, or certify ownership of a physical item.

Distributed ledger technology, such as blockchain technology, uses independent digital systems to record, share, and synchronize transactions, the details of which are recorded simultaneously on multiple nodes in a network. A token is an entry of data encoded on a distributed ledger. A distributed ledger can be used to identify ownership of both fungible tokens (such as cryptocurrency, as described in Rev. Rul. 2019-24) and NFTs.

Treatment of Collectibles Under Code Sec. 408(m) Within Certain Retirement Accounts

Code Sec. 408(m)(1) provides that the acquisition by an individual retirement account (IRA) of a collectible is treated as a distribution from the IRA equal to the cost to the IRA of the collectible. Code Sec. 408(m)(1) also provides that the acquisition by an individually directed account under a qualified plan under Code Sec. 401(a) of a collectible is treated as a distribution from the account equal to the cost to the account of the collectible.

Under Code Sec. 408(m)(2), the term "collectible" means: (1) any work of art, (2) any rug or antique, (3) any metal or gem, (4) any stamp or coin, (4) any alcoholic beverage, or (5) any other tangible personal property specified by the Secretary for purposes of this subsection. Code Sec. 408(m)(3) provides that certain coins and bullion are excluded from the definition of collectible.

Whether an asset is a Code Sec. 408(m) collectible is also relevant for other sections of the Code. For example, under Code Sec. 1(h)(4) and (5), the sale or exchange of a collectible (as defined in Code Sec. 408(m), but including the coins and bullion otherwise excepted from that definition under Code Sec. 408(m)(3)) that is a capital asset held for more than one year is subject to a maximum 28 percent capital gains tax rate (while an asset that is not a collectible is generally subject to a lower maximum long-term capital gains tax rate). The definition of collectible under Code Sec. 408(m) is also relevant to Code Sec. 45D (new markets tax credit), Code Sec. 1397C (enterprise zone business defined), Reg. Sec. 301.6111-1T, Q&As-24 and -57E (tax shelter registration), and Notice 2004-50 (regarding permissible investments for personal savings accounts).

Notice 2023-17

In Notice 2023-17, the IRS stated that it intends to issue guidance regarding the treatment of certain NFTs as Code Sec. 408(m) collectibles.

Pending the issuance of that guidance, the IRS intends to determine whether an NFT constitutes a Code Sec. 408(m) collectible by analyzing whether the NFT's associated right or asset is a Code Sec. 408(m) collectible (referred to as the "look-through analysis"). Under the look-through analysis, an NFT constitutes a Code Sec. 408(m) collectible if the NFT's associated right or asset is a Code Sec. 408(m) collectible. Similarly, an NFT does not constitute a Code Sec. 408(m) collectible if the NFT's associated right or asset is not a Code Sec. 408(m) collectible.

Example: A gem is a Code Sec. 408(m) collectible under Code Sec. 408(m)(2)(C), and therefore an NFT that certifies ownership of a gem constitutes a Code Sec. 408(m) collectible. However, a right to use or develop a "plot of land" in a virtual environment generally is not a Code Sec. 408(m) collectible, and therefore, an NFT that provides a right to use or develop the "plot of land" in the virtual environment generally does not constitute a Code Sec. 408(m) collectible.

According to the IRS, applying the look-through analysis to an NFT if its associated right or asset is a digital file raises the question as to whether the digital file constitutes a "work of art" under Code Sec. 408(m)(2)(A) (in which case, the NFT would be a Code Sec. 408(m) collectible). The IRS said that it is considering the extent to which a digital file may constitute a "work of art" under Code Sec. 408(m)(2)(A).

For a discussion of the tax treatment of investments in collectibles by retirement plans, see Parker Tax ¶134,535.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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