Non-fungible tokens, or NFTs, are experiencing a resurgence this year. While still far from 2021’s highs, trading volume surpassed $400 million for three days in 2024. And that means NFT regulations are still on the radar—from the PTO to the IRS.
The good news is that some agencies are moving toward more regulatory clarity, as was the case with the recent report from intellectual property regulators.
In this article, we’ll examine the recent decision regarding intellectual property and how other regulatory agencies are handling NFTs.
A Brief NFT Primer
NFTs are digital assets that represent tangible, real-world, or digital items. By tokenizing the asset on a blockchain, NFTs simplify trading and provide verifiable proof of scarcity, authenticity, and ownership.
For example, the Bored Ape Yacht Club NFT collection consists of digital tokens pointing to a unique ape image on a server. While anyone can copy these images, the NFT provides proof of ownership and authenticity.
There are several types of NFTs:
- Artwork. Profile, generative, or just plain fine art can all exist as NFTs. Most of the highest-priced NFTs are artwork.
- Gaming. Many play-to-earn games leverage NFTs to represent avatars or in-game items, making them easier to trade outside of the game ecosystem.
- Soulbound Tokens. Ethereum’s Soulbound tokens are NFTs intended to represent a persona online, making it easy to authenticate and transact.
- Sports Collectibles. Many card makers have turned to NFTs to monetize their IP involving sports players or other people.
- Physical Assets. Tokenizing real estate or other physical assets can make them easier to trade while creating a record of ownership.
The diversity of NFT use cases makes it challenging for regulators to keep up. For example, the IRS can’t broadly classify NFTs as collectibles if some are in-game items. And the SEC can’t classify all NFTs as securities since Soulbound tokens are inherently worthless.
No Changes to Existing IP Laws
NFTs have become popular digital collectives, but the market has become a legal minefield. Since anyone can easily and anonymously mint NFTs, producing “collectibles” that infringe on real-world trademarks is easy.
For example, Hermes sued the creator of the MetaBirkins NFT collection for infringing upon its highly coveted Birkin handbag brand. While the creator argued that free speech covered the works, a U.S. jury found that MetaBirkins infringed upon the Birkin trademark.
So, in 2022, Sen. Patrick Joseph Leahy and Sen. Thom Tillis initiated a study to determine whether current intellectual property laws were adequate to address concerns about copyright and trademark infringement associated with NFTs.
After three public roundtables and commentary periods, the USPTO and the U.S. Copyright Office produced a 112-page report calling current laws adequate. NFT advocates generally saw this move as a successful path to avoid stifling regulations.
Despite the lack of new regulation, ongoing IP infringement could remain a key issue affecting the NFT industry. Companies may have to spend money defending their brands in court against fly-by-night NFT projects capitalizing on their brand’s value.
The SEC’s Consistent Message
The SEC has consistently pushed to classify many digital assets as “securities.” But, while cryptocurrencies have been targets for about a decade, the agency’s lawsuit against Impact Theory in August 2023 brought NFTs into the enforcement spotlight.
Impact Theory sold three tiers of NFT collectibles while suggesting that investors would profit from them. As a result, the SEC asserted these qualified as securities (e.g., investors bought with the expectation of a profit) rather than just collectibles.
Impact Theory ended up settling with an agreement to reimburse investors and pay the SEC a $6.1 million fine. However, the SEC was careful not to suggest that all NFTs are securities—in fact, most will likely remain non-securities.
IRS Definition in the Works
The IRS clarified that all virtual currencies and digital assets, including NFTs, are “property.” As such, they are subject to ordinary income and capital gains taxes like stocks, and you should not treat them as currencies.
However, in March 2023, the Treasury and IRS began soliciting feedback for upcoming guidance regarding the tax treatment of NFTs as ” collectibles” under the tax law. If deemed a collectible, the asset would be subject to a long-term tax rate of up to 28%.
Moreover, the acquisition of a collectible by an IRA or other qualified plan is a distribution from the account equal to the cost of the collectible. As a result, the classification ostensibly excludes NFTs from tax-advantaged accounts.
If the guidance is issued, the IRS intends to determine whether an NFT is a collectible using a “look-through analysis.” The approach involves “looking through” the digital nature of the asset to determine what it “represents” (e.g., artwork, collectibles, etc.).
However, the “look-through analysis” introduces some challenges. For instance, existing crypto tax software may be unable to differentiate between collectible and non-collectible NFTs, requiring manual tracking and reporting measures. Furthermore, some experts question whether the added effort would even help raise the IRS’ tax haul.
Regulations Beyond NFTs
NFTs have become one of the clearer pictures regarding crypto regulations. With final IP regulations, a mostly hands-off approach from the SEC, and newly issued IRS guidance, NFT collectors and investors know what to expect.
The same isn’t true for other crypto assets.
The SEC continues to insist that all cryptocurrencies aside from Bitcoin may be securities that fall under its purview. Rather than clarify this tax treatment, the agency insists on pursuing a “regulation through enforcement” approach.
While the IRS insists all crypto assets are property, the nature of some crypto ecosystems creates ambiguity. For example, it’s unclear whether locking up crypto in a cross-chain bridge creates a taxable event (e.g., whether it’s “sold” or not).
Many compliance processes are also time-consuming and out-of-date. For example, to purchase a coffee with Bitcoin, the IRS requires you to look up the price you purchased Bitcoin for and the price when you made the purchase and pay capital gains tax on any increase in value. And that process is enough to deter Bitcoin use for that purpose!
Similarly, the process of sending 1099-DAs to every DeFi participant is enough to shut down many fully decentralized and frictionless protocols where it’s not practical to know every user’s identity.
ZenLedger simplifies the tax filing process. Source: ZenLedger
That said, everyday collectors and investors can avoid problems using crypto tax software that automates much of the compliance process. For instance, ZenLedger (pictured above) aggregates transactions across exchanges and computes your tax obligations.
The Bottom Line
NFTs continue to be an active area of focus for regulators. While intellectual property laws are well-defined at the moment, the SEC and IRS continue to update their approaches to the industry to ensure investors are protected and taxes are paid. The broader crypto ecosystem faces even more questions about compliance requirements.
If you trade NFTs or other crypto assets, ZenLedger can help organize everything for tax season. Our platform aggregates transactions across wallets and exchanges, computes your capital gains and losses, and generates the paperwork you need to file. You can also find ways to reduce your taxes through tax-loss harvesting!
This material has been prepared for informational purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.
