NFTs - what is the fuss about?

What Is an NFT?

Also known as the non-fungible token, NFT is a digital ledger or blockchain's information unit. NFTs represent a unique digital item that you cannot interchange with something else. NFTs are representations of physical and digital goods such as video game items, physical or digital goods such as documents, video, audio, artwork, and other creative work that may not be the work itself.

It is pretty similar to the VIN number of your car or the serial number of your mobile device. That is because it represents your vehicle or phone but is not them at all.

For NFTs, the person with that asset is not the one who owns it. The owner only has the record and hash code as proof that they own the asset. Another individual may use your car or phone, but you will be the only one who can prove to own it. This concept challenges the idea of ownership that can be either strange or noble.

What Is The NFT Platform NBA Top Shot?

In the past two years, the NBA or National Basketball Association with the NBPA or players union became partners with the blockchain company based in Vancouver called Dapper Labs. They developed an advanced digital platform that they referred to as the NBA Top Shot. Right now, this platform is spearheading the evolution of the landscape on sports collectibles.

The NFT or non-fungible token marketplace called Top Shot became publicly available last October after closed beta testing. Here, fans were able to trade, sell, and purchase NBA moments. These included highlight clips in the package that operated similar to trading cards. It functions similarly to how sports enthusiasts are collecting physical goods. Top Shot became effective in providing a digital realm for people to invest because their highlight collections increase in value over time.

According to a report from the Business Insider, the platform was able to register around 800 thousand users that interacted with one another on the Discord messaging platform of Top Shot. Top Shot eventually generated sales of more than $500 million. LeBron James' dunk is the most priceless moment in his game competing with the Houston Rockets as it got sold for around $387,600. The NBPA, NBA, and Dapper Labs shared the revenue from these transactions.

Dapper Labs' head of partnerships, Caty Tedman, spoke at SportsPro Live.

She explained that NBA Top Shot aims to provide the collectors with a new generation of experience. With it, you can take a part of basketball's economy and collect the players you love, including their best plays, to have a community built around it. Since millions of people are talking about basketball online every day, they are now a basketball collector community.

NBA Top Shot allows the experience to be available online, which is why it is highly global and provides an opportunity to get a bigger audience to play with, collect with, and buy, sell, and trade with others. The blockchain elements provide the ability to have these assets digitally owned, just like how you can hold physical cards. With it, you can truly become the owner of your Top Shots in the digital realm.

What Regulates NBA Top Shot?

Dapper Labs has tapped alchemy to provide the blockchain a boost to power NBA Top Shot. The NBA Top Shot accounts of Flow were able to account for more transactions than every other NFT project.

The backbone of the significant part of the DeFi (decentralized finance) realm is partnered with the blockchain Flow that the team behind NBA Top Shot created. It is now the leading foray into the NFT or non-fungible tokens' explosive realm.

Dapper Labs, the creator of CryptoKitties, started to work with Alchemy several years earlier. Their partnership will give NBA Top Shot's Flow the same amount of support. According to Roham Gharegozlou, the CEO of Dapper Labs, NBA Top Shot has accounted for more transactions than all other NFT projects.

Alchemy is a type of AWS or Amazon Web Services that powers blockchains. They provide developers with tools so it would be easier for them to build user-friendly services. Typically, it means that devices can provide better transparency, improve their performance, and debug their code.

According to Nikil Viswanathan, the CEO of Alchemy, the infrastructure underneath the hood is powered by AWS whenever you open Airbnb, Netflix, or Uber. The same thing is what alchemy does when it accesses blockchains.

Flow was able to distinguish itself with five specialized types of nodes that can perform specific roles in the ecosystem from "access," "verification," "consensus," "execution," and "collection." The firm claims that using their system instead of sharding can provide the network with better data throughput and speed.

Whenever people sign up, they get emails on the products of CoinDesk, and they will have to agree to the privacy policy, including the terms and conditions. On a large scale, flow can achieve this with a beautiful user experience and meager fees. However, if you don't have Alchemy, you may need to build all of it on your own. These are developer tools that help Flow begin from a blockchain with six applications to one with thousands or more in just several months.

To give the burgeoning ecosystem of Ethereum connective tissue, some systematically vital companies emerged. These are Infura, which ConsenSys, and Alchemy own. Proof-of-stake investment and DeFi have the other essential furniture that includes the Bison Trails owned by Coinbase and MetaMask that ConsenSys holds.

These offerings are infrastructure that got beefed up to ensure that the blockchain users can smoothly access the services and enjoy an uptime of 100%. However, this concentration may potentially lead to failure.

According to Gharegozlou, Infura has been highly dominant at one point as Alchemy, and some various options are now available that are not as specialized when it comes to Ethereum.

NFT and Taxes

You may be wondering where you need to pay taxes for capital gains from NFTs. You might have heard that the IRS does not recognize them as property so, in theory, there should be no taxable event when one sells an NFT. However, this is often not the case.

Where Does One Need To Pay Taxes For Capital Gains From NFT's?

In case you recently bought an NFT, this is what it could mean for your taxes. The tax law has always been intended to be applied to tangible property. Since purchasing an NFT is a digital asset wherein you get a piece of the code, it is considered an intangible property that may not be subject to sales tax in New York.

However, since there are now incredible sums of cash shelled out for certain NFTs, New York may eventually decide to have this issue revisited in the future, which is why this issue needs to get monitored.

Yet, having sales tax rules amended to include NFTs, which are intangible properties, could end up raising a lot of philosophical and legal issues. It consists of the location of the NFT for tax purposes. If the server is located in New York, would that be enough physical presence to declare the state for taxation? When intangible NFTs become subject to New York sales tax, the same may apply to bonds and stocks that are electronically traded on the NYSE or NASDAQ.

The revenue of the New York State may increase when they apply sales tax to NFTs. However, the only group that would become rich would be the tax lawyers needed for this issue.

How about the capital gains tax? Collectors who purchase a painting for $1 thousand and sell it for $200 thousand will have a tax bill incurred on the difference. Could you apply the same for NFTs if you buy and flip an NFT that has tripled in value?

Taxes in federal gains can only be applied to properties that people own as investments. Typically included are properties that are not artworks, collectibles, bonds, stocks, cars, and first homes. Because of that, NFTs also qualify for this.

For investors and collectors, they should treat NFTs as a capital asset. When they sell an NFT, the imposed capital gains tax will be at a long-term or short-term rate that would depend if the asset has held it for more than a year.

Short-term rates kick in whenever the asset gets sold after getting held for less than a year, which can be higher than the rates in the long term.

What Are The Tax Implications If I Used Cryptocurrency Such As Ether Or Bitcoin To Purchase NFT?

Here, things can be pretty challenging as cryptocurrencies and NFTs are tightly linked to each other. You may not need to have cryptocurrency to purchase an NFT, but so many buyers have them. It includes the people who bought the Beeple, which is worth $69 million.

The webpage of the USA's Internal Revenue Service has frequently asked questions on cryptocurrency. It includes specific language when it comes to income returns that ask taxpayers if they were able to "sell, receive, send, exchange, or otherwise able to acquire a financial interest in cryptocurrency in the past year.

It means that the government is now starting to become serious about cryptocurrency.

Even if things may appear overwhelming, the rules of the IRS are pretty straightforward. You may have bought Ether in the past few years at $100, and it now has a price of $1800. Since Ether is considered by the IRS as a capital asset, using it to buy an NFT can turn it into a taxable event.

From the IRS point of view, you pay an appreciated asset when you don't spend currency. It is similar to selling a painting at an auction that significantly increased in value since you have bought it. Because of that, you will be required to have your capital gains reported for that year's tax filing.

Can It Be Possible To Have A Tax Break Whenever I Have My NFT Donated To A Museum?

Since this territory is relatively new, people would have to watch the space to see the evolution of the regulations. Right now, the answer to this is yes, but it has some limits.

Whenever you have it donated to a museum, you will get a benefit similar to any artwork as long as the IRS vetted it and you did it correctly. Whenever a collector allows an NFT that has been part of their collection for a minimum of one year donated to a museum, it will become eligible for deduction in a charitable contribution with the same amount as the property's fair-market value.

At the beginning of 2020, there have been tighter legal regulations that aimed to crack down on money-laundering in art trade and antiquities that initially happened in the UK and eventually occurred in the US. According to law, it is required for art-related companies to identify the "ultimate beneficial owner" of a sale. Because of that, collectors found it difficult to conceal their identities. Yet, can this affect the sales of NFT? NFTs are a kind of crypto asset that is not defined as a 'work of art' in the money laundering regulations of the UK. NFTs have been effective in mimicking cryptocurrencies that people can use in the same ways that could lead to identical risks. They are, in reality, more like investment vehicles instead of tradeable artwork.

What Tax Consideration Applies For NFTs?

If you just purchased an NFT, what could it mean for your taxes? Do you need to pay taxes for NFTs? Would it matter if you "store" the token abroad or in the US? Since there are now tighter rules on money laundering, how can this impact the trade?

Since so much money is flying around, there can be so many things at stake. Collectors who purchase a painting in New York will owe the state use tax as paintings are also physical goods. Does this also apply to NFTs?

The answer to this is no.

Since the sales tax law has been enacted for more than five decades, it has not considered digital art as a concept. The tax law has always been intended to be applied to any tangible property that you own. The NFT is a digital asset as it is, in essence, a code in the blockchain. Because of that, you can consider NFT as an intangible property that is not subject to the sales tax of New York.

However, since there is now so much money shelled out for NFTs, it wouldn't be surprising for the state to revisit this issue eventually, so it would be best to monitor this constantly.

Danziger has noted that the amendment of the rules in sales tax to have NFTs or other intangible properties included can raise so many philosophical and legal issues that include the exact location of the NFT for tax purposes. If it is located in one of New York's servers, could that be enough physical presence to consider taxation in that state? If the intangible NFTs become subject to sales tax in New York, should that apply to electronically traded bonds and stocks on the New York Stock Exchange or NASDAQ?

New York's revenue can increase from the sales tax that they apply to the NFTs. However, the group that will become rich will be the tax lawyers that people will hire for litigation.

How about the tax on capital gains? A collector that purchased a painting for $1,000 and sold it for $90,000 would have a tax bill incurred on the difference. Could the case be the same for the NFTs? What would happen if the collector purchases and flips the NFT that has more than tripled in value?

Taxes in federal capital gains would apply to properties that people own as investments. Typically, these include bonds, collectibles, stocks, cars, artworks, and not first homes.

Because of that, NFTs are qualified.

Thus, for investors and collectors, and not dealers who hold NFTs as part of their inventory, they should treat NFTs as a capital asset. When they sell an NFT, they can have the capital gains tax imposed at a long-term or short-term rate that would depend if the owner held the asset for more than a year.

If the asset gets sold after holding it for less than a year, short-term rates will kick in, which can be higher than the long-term rates.

What could be the tax implications if you used cryptocurrency like Ether or Bitcoin to purchase your NFT?

It can be challenging as cryptocurrencies and NFTs are tightly connected. You may not need to use cryptocurrency whenever you purchase an NFT. However, most of the buyers do this.

The USA's Internal Revenue Service has a website that has frequently asked questions on cryptocurrency. It includes the specific language on income returns that ask taxpayers if they could "sell, receive, exchange, send, or otherwise acquire a financial interest in virtual currency" in the previous year.

It is proof that the government is now taking cryptocurrency very seriously.

Despite being overwhelming, the rules of the IRS are reasonable and transparent. You may have bought Ether for $100 in the past five years that is now worth $1,800. The IRS considers Ether as a capital asset. When you use it to buy an NFT, it can be a taxable event.

From the IRS point of view, you don't spend currency, but you are paying an asset that has been appreciated. It is quite the same as selling a painting at an auction that has significantly increased its value since you purchased it. You will be required to have your capital gains reported for your tax filing that year.

In case I donated my NFT to a museum, can I possibly get a tax break?

Since this territory is relatively new, we need to observe the space to see the evolution of the regulations. However, right now, the answer to this is yes, but it has some limits.

Having it donated to a museum will allow you to get a benefit similar to any artwork as long as you do it correctly and the IRS has vetted it.

Whenever a collector has an NFT donated, which was part of their collection for a minimum of one year to any museum, they will become eligible for a deduction in a charitable contribution that has an amount that is equal to the property's fair-market value.

In the UK, at the start of 2020, there are tighter legal regulations that aim to crack down on money-laundering in art trade and antiquities. That is what recently happened in the US. It is required by law for art-related companies to identify the sale's "ultimate beneficial owner." Because of that, it is now more difficult for the collectors to hide their identities. However, can this affect the sales of NFTs?

Since NFTs are still in their early days, it can be hard to tell. NFTs are a kind of crypto asset that is not included in the 'work of art' definition of the regulations on money laundering in the UK. NFTs effectively mimic cryptocurrencies that they can use in the same way, leading to the same risks. They are, in reality, more like investment vehicles instead of tradeable art. Because of this, it would be better to review this space for updates constantly.

Wrapping It Up

After reading this post, you should now know what NFTs are and how they can be used. If you want to learn more about the legal implications of using these digital goods, check out more of our blogs. We hope that we have sufficiently educated readers on blockchain technology and its potential uses in a variety of industries!