Non-fungible tokens (NFTs) are all the rage these days. People are literally bidding thousands to own these collectibles and some are even selling for millions. If your loved ones are into digital art and cryptocurrencies and enticed by the possibility of striking it rich off a speculative investment, gifting them a NFT could be a great option.

Key Takeaways

  • NFTs are stored in a digital wallet and usually paid for with a cryptocurrency—primarily Ethereum.
  • NFT marketplaces operate auctions or the option to buy at a fixed price, similar to eBay.
  • The IRS has yet to issue any specific guidance on NFTs, making these digital assets complex from a tax perspective.

What Are NFTs?

An NFT is essentially a digital file that comes with ownership rights. Anything in digital format can qualify, including pieces of art, sports cards, memes, videos, and audio, and once “tokenized” they can be bought and sold online.

If you’re new to all this, you might be wondering why people are spending thousands or even millions of dollars on files they could probably quite easily view and download for free. The answer is exclusive ownership.

When you buy an NFT, you receive a digital token that functions as a certificate of ownership. This title is registered and stored on a shared ledger known as the blockchain, the record-keeping technology behind the Bitcoin network, so that everyone knows you are the proprietor and have the right to sell the asset. A digital file can be easily and repeatedly duplicated. However, there is only one or a limited number of NFT versions of it.

It is only this year that the market for NFTs has lit up. In February, a 2011 meme of a flying pop-tart cat sold for more than $500,000. Shortly after, a JPEG of Everydays: The First 5000 Days, a digital artwork created by Mike “Beeple” Winkelmann, fetched $69 million at Christie’s.

It’s not just regular art that is “tokenized” and sold for big bucks, either. In March 2021, Twitter CEO Jack Dorsey put up for auction an image of his first tweet as an NFT token and ended up collecting over $2.9 million.

NFTs are highly speculative investments, with their value being based entirely on what someone else is willing to pay for them.

How to Gift an NFT

If you haven’t already got an NFT collection to gift, you’ll need to buy one. For non-cryptocurrency enthusiasts, this requires picking up a few key items first. Most NFT marketplaces only accept Ethereum, the digital coin, so you may have to purchase some of that virtual currency before bidding. You’ll also need a digital wallet to store NFTs and the cryptocurrency used to acquire them.

NFT recipients need a wallet to store them, while you, the donor, will probably need to stock up on Ethereum as the majority of NFT marketplaces only accept this virtual currency as a form of payment.

There are several NFT marketplaces online and each function slightly differently, including in terms of the assets they trade. Some sell a bit of everything, while others specialize in certain niches, such as sports and gaming.

Once you’ve found a suitable marketplace and have all the right tools to trade, it’s time to set up an account and start buying. NFT marketplaces operate in a similar way to eBay. Usually, there are auctions where the highest bidder wins, although some offer “buy now” options where NFTs are sold for a fixed price.

After you’ve made your purchase, the next step is to transfer the NFT to the person you want to gift it to. Many NFT marketplaces now offer this option, and it can usually be achieved with a few clicks of a button. Generally, you’ll need to select the item you want to gift, choose the option to transfer it, and then key in the recipient’s wallet address.

When gifting an NFT, make sure you input the recipient’s wallet address correctly. This is a blockchain transaction, meaning the transfer is irreversible and carries a gas fee—a payment made to compensate for the computing energy required to process and validate transactions on the Ethereum blockchain.

NFT Tax Considerations

Gifts surpassing $15,000, or $30,000 if made by a couple, are taxable events in the eyes of the Internal Revenue Service (IRS)—unless the recipient is your husband or wife. If you plan to be this generous and risk exceeding the lifetime gift tax exemption, which as of 2021 is set at $11.7 million, you might be hit with a hefty tax bill.

If that’s not an issue, the only tax liability will lie with the recipient when they eventually decide to sell. NFTs, like stocks, are subject to capital gains taxes. So, for example, if you bought an NFT for $500 (your cost basis) and the recipient then sold it for $1,000, the donee would be taxed on a capital gain of $500.

How much tax you would pay isn’t cut and dried. NFTs are a relatively new phenomenon that the IRS hasn’t fully addressed, leaving them somewhere in between cryptocurrencies, which are taxed as property with a long-term capital gains tax rate that varies from 0 to 20% based on income, and collectibles, which are defined by the IRS as “any work of art” and taxed at a higher rate of 28%.

If that wasn’t a big enough headache, there are also the cryptocurrencies used to buy NFTs to consider. These virtual currencies are known to fluctuate in value and every time one is disposed of for more or less than it was bought for it triggers a taxable event.

Given these various complexities, it’s probably a good idea to get in touch with a tax advisor before buying and gifting NFTs.