Treatment of certain NFTs as ‘collectibles’

The Notice provides both interim guidance on whether certain NFTs are characterized as collectibles under section 408(m), as well as soliciting comments on the future guidance.

Background. Section 408(m) defines the term ‘collectible’ by reference to a list in Section 408(m)(2), which includes works of art, antiques, metals, or gems, or “any other tangible personal property specified by the Secretary for purposes of this subsection.” 

Treatment of the NFT versus the ‘associated right or asset.’ In assessing whether an NFT represents ownership of a collectible, the Notice begins by distinguishing between the NFT — defined as 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.” — and the ‘associated right or asset’ (i.e., the right underlying the NFT) “that is typically separate from the NFT.”  

Examples of ‘associated rights or assets’ mentioned in the Notice include ownership of a digital file (such as a digital image, digital music, a digital trading card, or a digital sports moment) and rights that relate to non-digital assets (such as right to attend a ticketed event or certify ownership of a physical item).

Observation: The focus of Treasury and the IRS on the separability of the NFT from the rights underlying the NFT raises questions where the rights held in the NFT are considered coterminous with, and cannot be separated from, the NFT itself.

The Notice notes in a footnote that a digital file is not the same as a digital asset, as defined by Section 6045(g). For purposes of reporting by brokers under Section 6045(g), a digital asset is defined (except as provided by Treasury) as any digital representation of value that is recorded on a cryptographically secured digital ledger or any similar technology as specified by Treasury.

Observation: The description of an NFT as a ‘unique digital identifier,’ combined with the footnote clarifying that the underlying digital file is not a ‘digital asset,’ highlights the challenging questions in defining ‘digital assets’ for broker reporting purposes.

Interim application of a ‘look through’ approach. Pending issuance of future guidance, Treasury and the IRS intend to determine whether an NFT constitutes a ‘collectible’ (as defined in Section 408(m)) by ‘looking through’ to whether the NFT’s associated right or asset is a Section 408(m) collectible. 

The Notice provides an example where an NFT which certifies the ownership of a tangible gem (which is itself a Section 408(m) collectible) is considered a Section 408(m) collectible, while an NFT that certifies a right to develop or use a ‘plot of land’ in a virtual environment generally does not constitute a Section 408(m) collectible. 

The Notice highlights that Treasury and the IRS are considering the extent to which a digital file can constitute a ‘work of art’ under Section 408(m).  

Observation: The look-through approach raises questions where an NFT represents the rights to multiple things at once – for example, the purchase of a piece of digital art also may entitle the holder to attend an event, or an NFT representing a concert ticket could contain a digital file designed by a famous artist (and, thus, itself be a ‘work of art’).

Request for comments

The IRS and Treasury request comments by June 19, 2023 on a detailed list of topics addressed in the Notice, including the Notice’s definition of an NFT, as well as any considerations concerning application of the look-through analysis in determining collectible treatment of certain NFTs.  The Notice also requests comments on what other guidance relating to NFTs would be helpful.