Rounding it up
NFTs, or non-fungible tokens, are digital assets like GIFs, images, songs, tweets, or sports plays.
NFTs allow creators to continue to profit off the sale of their art with embedded royalties, using blockchain technology to track ownership.
Canada taxes NFT sales depending on the type of income realized at sale; they’ll either be business or capital gains.
The world in 2021 is very different from the one in 2001. Twenty years has seen the meteoric rise of the internet, unimaginable leaps in mobile phone technology, and a new emphasis on the digital world. In 2001, we saw a lot of folks collecting playing cards. In 2021, however, it’s now possible to own, not just a tangible playing card, but an actual digital moving image of them running for the end zone or shooting a three-pointer via non-fungible tokens, or NFTs. They have not only changed the way we think about art and collectables, but also have made them more valuable than ever before.
With the increasing values of selling and buying NFTs, one question comes to mind: Do you have to pay taxes on NFTs? Canadian law is pretty clear here. Read on to learn more about if and how NFTs are taxed in Canada.
What exactly are NFTs?
It can be a bit hard to grasp exactly what an NFT is in the first place. Essentially, NFTs are any digital item that can be exchanged using blockchain technology. But wait — what’s blockchain? It’s a fancy technological term for a process by which every transaction can be logged and tracked, visible to every individual who wants to take a look. Now, back to NFTs. Each NFT can only have one owner. The non-fungible part of the NFT means that it can be made unique from other items.
By way of example, a bitcoin is a fungible token. One bitcoin will always equal one. The value of one bitcoin may go up or down but one coin will always be worth the same amount as another. NFTs, however, are more like classic cars. You could exchange a 1967 Ford Mustang for a 2001 Nissan Altima, but those two things will never be equal. The Mustang will (more than likely) always be worth more than the Nissan because it is a highly sought after vehicle; folks will pay quite a bit to own one. They will not, likely, pay very much to own your clapped-out Nissan. This is an example of a non-fungible asset — one cannot be directly exchanged for another.
Another interesting trait about NFTs is that anyone can make it. For example, I could go on my laptop right now and post for sale a scan of my daughter’s artwork. It will never, however, be as valuable as digital artwork by artist Beeple, who recently sold an NFT for $69 million. If it is, that’d be great, but I’m not counting on it. Artists can also code commission payments right into NFTs. This means that, unlike physical artwork, they can get paid each time the NFT is exchanged.
So just like any other collectible, NFTs can increase and decrease in value and aren’t directly interchangeable. The question is, do you have to pay tax on that increase?
Does Canada tax NFTs?
The might, depending on two things:
How you interact with NFTs
The type of income you realize in the process.
In short, buying an NFT is not a taxable event. Selling an NFT, however, whether you’ve created the NFT or are selling an item you purchased previously, is a taxable event. In essence, there are two different ways your NFT could be taxed.
Creating and selling an NFT is exactly like creating and selling anything else, and therefore qualifies as business income. If you were a store owner selling widgets, you’d pay taxes on the income from those sales, minus any applicable business expenses. Let’s say you decide to create your own NFT of your cat and list it for sale. Perhaps it sells for $100. The Canadian government views that $100 as income and you should pay tax on it as such. So, you’ll owe a certain percentage of the sale price. You can also deduct your cost for creating the asset you’ve sold. So, if you purchase a new computer to create the token, you can write off the cost. The same is true for royalties from NFT sales. Say your cat NFT is doing well and it gets sold several more times. The royalties you receive from the sale are taxed as business income.
Income tax in Canada ranges from 15% to upwards of 30% and scales based on income. Provinces (except Quebec) also calculate and charge income tax.
Capital gains & investment income
The other way your NFT can be taxed is as capital gains and investment income. Taxes work a bit differently if you decide to invest in an NFT. If you purchase an NFT and it gains value over a few months, then you sell, you’ll have to pay capital gains tax on the increased value. Let’s say you purchase an NFT for $100 on January 1 and on March 1, sell it for $1,000. First of all, congratulations. Secondly, prepare to pay capital gains taxes on that $900.
There is a slight exception to this rule. If trading NFTs is your primary source of income, like a day trader on the stock market, then some of this income could be considered business income. Moreover, if you undertake certain actions while investing in an NFT, you may not have to pay full capital gains taxes but instead, file it under investment income. This gets very technical very quickly and likely doesn’t matter to the layperson reading this. If you are here, however, it’s best to talk to an accountant or financial professional before moving forward. You could find yourself in a tough spot if you do not.
The taxes you’ll have to pay here vary widely because you can offset your capital gains with capital losses. Say you sold that NFT for $1,000 after buying it for $100, resulting in a capital gain of $900. You’ll be able to write that against any money you lost selling other NFTs or cryptocurrencies. Once again, this gets complicated quickly so consulting a financial professional may be in your best interest.
NFTs as investments
If you like collecting, NFTs can be an interesting and potentially lucrative hobby. It should not, however, be viewed as an investment for income and should not replace your savings or Registered Retirement Savings Account. Just like gambling or the stock market in many ways, you should be prepared and able to lose the entire amount you’ve invested.
NFTs are taxable under Canadian law and the Canada Revenue Agency will expect their dues when you sell your NFTs. The type of tax you have to pay will depend heavily on if you created and sold the NFT yourself or if you’ve purchased an existing NFT and it has since increased in value. The profits will be taxed as business income for the former and capital gains for the latter. If you’re anything more than a small-time NFT owner or exchanger, consider hiring the services of a financial professional to help you sort through the tax web of NFT sales.
Dan is a runner and writer living in the Washington, D.C. area, where he currently works for a financial services trade association as the Communications Director.