7727.01 / What is a non-fungible token (NFT)?

Non-fungible tokens are a type of unique digital asset or digital file. A non-fungible token, or NFT, can represent any type of real-world items, including artwork, images, recordings, gaming awards or other files. These digital assets can last indefinitely and can be sold or exchanged like any other piece of property. These digital assets have recently become extremely popular due to purchases by celebrities and are typically bought and sold online (popular sites include OpenSea and Rarible). Often, these assets are purchased with virtual currency.

An NFT contains a unique identifying code and is linked to a certificate of authentication. Ownership of the NFT can be verified by the digital ledger, or blockchain, where that certificate/unique code is recorded. The actual value of the non-fungible token is found in the underlying asset and the “token” itself represents ownership. A common comparison is a car and the car’s title (the token would be similar to the car’s title, where the underlying asset is similar to the car itself).

The unique ownership code is what makes NFTs different from virtual currency, such as bitcoin or Ethereum. Each type of cryptocurrency is fungible, meaning that the value of one unit of bitcoin is always equal to any other unit of bitcoin (although the IRS has held that different types of virtual currency are not of a “like kind”). The digital code linked to the NFT makes the NFT different from all other NFTs.

The token/code associated with the NFT can also provide information about the creator’s rights in the property after sale. For example, an embedded contract in the NFT can give the creator the right to collect royalties any time the NFT is sold, licensed or transferred in the future. The imbedded contract can even give the NFT creator the right to receive payment anytime the NFT is viewed or downloaded.

While each NFT has a unique code, it is possible for the creator to create multiple replicas of the same underlying image or asset. When the NFT creator “tokenizes” the asset, it does not always mean that the purchaser has sole rights to the underlying image or asset. It is possible that the image or work itself could remain available for downloading by members of the general public. Instead, it may be more helpful to compare the NFT to an autographed copy of the original asset.

NFTs are often transferred in transactions involving virtual currency. While the IRS has begun to issue more robust guidance on virtual currency transactions, it has yet to fully weigh in on the tax treatment of NFTs themselves. Since the tax treatment of NFTs is evolving, it becomes particularly important that taxpayers who engage in transactions involving NFTs consult experienced tax counsel and pay close attention to this evolving area of taxation.