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IRS and Treasury issue new guidance on NFT taxation

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(Kitco News) - As the U.S. government moves to get a regulatory handle on the cryptocurrency ecosystem, the Treasury Department and the Internal Revenue Service (IRS) have issued new guidance on non-fungible tokens (NFTs) and are asking for feedback on their plan to tax them as a collectible under the current tax law.

NFTs have seen a significant rise in popularity since the bull market of 2021, with billions of dollars worth of transactions happening on NFT marketplaces like OpenSea, LooksRare and Blur. The industry has proven a tough one for regulators to reign in as the decentralized nature of the market allows transactions to occur from anywhere in the world.

There are also numerous accusations of rampant wash trading and money laundering occurring via NFT markets, leading the industry to become a point of focus for global regulators looking to clamp down on illegal activities.

The IRS and Treasury appear to be particularly concerned about the purchase of NFTs in retirement accounts and the dangers they pose to the long-term financial health of retirees.

“Section 408(m)(2) of the tax code provides for a specific list of items that constitute collectibles for certain purposes,” the announcement said. “Acquisition of a collectible by an individual retirement account (IRA) or individually-directed account of a qualified plan is treated as a distribution from the account equal to the cost to the account of the collectible. Generally, collectibles also do not have as advantageous capital-gains tax treatment as other capital assets.”

Until a clear regulatory framework is established in regard to NFTs, the IRS will use a “look-through analysis” to determine when an NFT is treated as a collectible.

“Under the look-through analysis, an NFT is treated as a collectible if the NFT's associated right or asset falls under the definition of collectible in the tax code,” the IRS said. “For example, a gem is a collectible under section 408(m); therefore, an NFT that certifies ownership of a gem is a collectible.”

Interested parties can provide comments to the IRS until June 19 on topics such as when an NFT is considered to be a work of art.

The IRS has been making a concerted effort to regulate the crypto industry over the past six months. In October, the tax collector released a draft bill proposing the addition of a well-defined Digital Assets section to the 2022 IRS tax forms that included detailed guidance on how to report on cryptocurrencies and nonfungible tokens (NFT).

In November, reports emerged that the agency's criminal investigation (CI) division was gearing up to bring the hammer down on crypto tax evaders and was building hundreds of cases focused on things like “off-ramping” transactions, where digital assets are exchanged for fiat currency, as well as people being paid for work in crypto and not reporting that income on their taxes.

The IRS ramps up its effort to crack down on crypto tax evaders

According to IRS special agent Thomas Fattorusso, who is in charge of IRS-CI’s New York field office, “Cryptocurrency is here to stay,” so the tax-collection agency is looking to partner with the crypto industry to fight financial crime.

Fattorusso said the agency could not take a hostile approach to the technology and instead must embrace it since “it isn’t going anywhere anytime soon and it’s becoming more legitimate as the years roll on,” along with becoming more sophisticated.

He stressed that it is a goal of the IRS to work towards getting more cooperation from crypto companies and developing a non-contentious relationship that is more symbiotic than oppositional. “It helps them in their legitimacy. This is a new industry for everybody. I think we’re still trying to feel our way around it. The companies are feeling their way around it.”

The IRS-CI boss also noted that the agency is currently in the midst of a hiring push with a focus on recruiting younger talent with a technical background that wants to dedicate their life to service, combat fraud, and do general law-enforcement work. “We’ve been very good about hiring data scientists in CI in the last few years, which is brand new for us,” he said.

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