NFTs, or non-fungible tokens, captured the investing world’s fancy over the past few years, as high-profile sales of digital art and other digital collectibles such as CryptoPunks soared in popularity and price. In total, $26.3 billion inNFTswere sold in 2022, according to CoinGecko, though that number slid to $11.8 billion in 2023 for what many see as a new frontier in digital investments.

With all that speculation, some traders are turning a profit, while creators of NFTs are also realizing income for their virtual designs. But in this fast-emerging market, the Internal Revenue Service (IRS) has yet to provide clear guidance on some issues surrounding taxes, creating further uncertainty.

So what should investors and creators knowas they’re filing taxesand how do they respond? Here are six things that those involved in creating and trading NFTs need to know.

1. Investors and creators don’t owe tax until an NFT sells

If you’re creating NFTs or trading them, you won’t owe tax until the NFT actually sells. In the case of a creator, it’s the same as anyone who produces something, such as a painting. When they sell that painting, they realize revenue on the production but not before. That incomewill be recognized as ordinary income and taxedas any other pay from work would be.

In the case of NFT trades, traders will owe taxes if they sell an NFT for a profit. But as long as they hold the NFT and don’t sell, they can sit on their unrealized gains without paying taxes.

And how will those NFT trades be treated for tax purposes? In March 2023, the IRS issued a statement that it intended to tax some NFTs as collectibles while others could be taxed at the more preferential capital gains rates.

The IRS says the tax treatment depends on the asset underlying the NFT. If that underlying asset is currently considered a collectible (such as art), then the NFT would be treated as a collectible. If it’s not a collectible, then it would be taxed at capital gains rates.

That treatment is important because different tax rates are applied to each type of gain, says Christopher Rogers, senior tax partner at Capital Fund Law Group in New York City.

If you treat NFTs as capital gains, you’ll oweon net profits. Rogers says that, depending on a filer’s income, this tax treatment is generally more favorable for individuals than treatment as a collectible, where rates could go as high as 28 percent.

The silver lining is that if you’ve realized a loss on a trade, you can net that against any gains. In fact,each year and deduct that from your taxable income.

If you’re using cryptocurrency such asto purchase NFTs, you could be creating a whole separate liability apart from the NFT itself. That’s because, due to how the IRS has structured the rules about using it.

You’ll create a tax liability if you exchange virtual currency for goods such as NFTs or services that are worth more than what your cost basis is in the cryptocurrency. For example, imagine you purchased Ethereum for $1,000 and then spent it on NFTs worth $3,000, you’ve created a tax liability and you’ll owe tax on that transaction. (You could also create a loss.)

The IRS rules have made it onerous to use cryptocurrency as actual currency, and they extend to any transactions involving crypto, such as the purchase of NFTs.

Some NFTs have embedded “” that pay the original creator a royalty every time the NFT is sold. For example, the creator might sell to Person A, who in six months sells the NFT to Person B. Depending on the NFT, the creator may realize a royalty of a few percent on that second-hand sale by Person A, creating a tax liability for the creator.

Of course, that second-hand sale could also generate a taxable gain or loss for Person A, depending on exactly the cost basis and the sale price of the NFT (see point 1 above) as well as the value received for the cryptocurrency (see point 2 above).

Other newer types of NFTs might represent an interest in an asset and generate income over time. If you receive income from these types of NFTs, you’ll owe tax at ordinary income tax rates, Rogers says. It’s treated just like other regular income.

The treatment of NFT income is in line with longstanding IRS rules on the issue of income. But what happens when a person is given an NFT? The situation is less clear.

For example, some big corporations have entered into the NFT space, including PepsiCo. In 2021, the soft-drink giant minted NFTs and gave them away free to consumers. Did this promotion create a tax liability for Americans who received the NFT?

In other circumstances, a giveaway of something valuable can create a liability. If you win a car on a game show, for example, you’ll likely owe taxes on it. But experts say that how the NFT is treated is unclear: Could it be a dividend in circumstances and an interest payment in others?

Also unclear is the NFT’s value and what reference price could be used to create a cost basis. While that game-show giveaway might have a retail price, what’s the “real value” of an NFT? If an NFT entitles the owner to a real physical asset, is that object’s value the NFT’s real value?

Experts — and even PepsiCo — recommend that. Even so, the IRS rules appear to be unclear.

If you’re trading NFTs and you make a profit, you owe taxes even if your NFT exchange or trading platform didn’t provide you a Form 1099 detailing your gains. Though 1099s are typical in more traditional financial markets and are routinely provided by stock brokers, other brokers may not yet provide them, even though theanddo so already.

You can use, just as you would if you were reporting trading activities in.

Some cryptocurrency traders may be convinced that they don’t owe taxes on their gains, but the IRS has been clear that they do and has been tracking down scofflaws. Similarly, if you have a gain from trading NFTs, the lack of a 1099 doesn’t free you from your tax liability.

Many states may start to look closely at taxing NFTs at the point of sale, especially if recent tests in Washington state, Pennsylvania and Puerto Rico fare well, opening up sales taxes on digital art.

Washington’s state government in 2022 made NFTs subject to sales tax and other taxes, and Puerto Rico has explored the possibility, including drafting laws that treat NFTs as part of digital products that are subject to sales tax.

Though some experts say that sales of NFTs already legally create a tax liability in states that tax digital goods, these states are receiving little, if any, revenue from them. So, more states may adopt regulations before too long that offer clearer — and enforceable — guidance on NFT sales.

Even if the IRS hasn’t officially ruled on some aspects of NFTs and other digital art, it doesn’t mean it gets you off the hook for paying taxes on income from selling them or gains from trading them. Those involved in the NFT market should stay alert as rules change and be careful that they’re following them closely.