Before reading this article, we suggest first reading our previous articles on NFTs and P2E gaming. While they’re of course different topics, several of the concepts in those articles are foundational to what we are discussing here with respect to metaverse NFTs.
- How Are NFTs Taxed?
- How Are Art NFTs Taxed?
- How Are Gaming NFTs Taxed?
- Are Crypto P2E (Play-To-Earn) Gaming Rewards Taxable?
The Metaverse and Its NFTs Are Coming
So whether we like it or not, the metaverse is upon us. Facebook changing their name to Meta caused the price of Decentraland (META) to more than quadruple – even though the two projects are unrelated. It simply lent more credibility to the concept of the metaverse, which is MANA’s entire proposition. Now Apple and other major corporations are now getting involved as well.
Who will control the metaverse and exactly what form it will take is still very much in the air. But it’s increasingly transitioning from theory to reality all the time and with that new “reality” are going to come metaverse NFTs.
So how are those NFTs going to be taxed?
As always, we stress that there is not currently any NFT-specific guidance from the IRS. Especially when it comes to more complex and nuanced topics such as utility NFTs and gaming/metaverse income, we believe it will take years if not decades to litigate. As such, these are simply our opinions and conjecture until more authoritative guidance becomes available.
But as we discussed in the articles mentioned above, the use case of each NFT is very likely to come into play.
Metaverse NFTs vs. Gaming NFTs
The metaverse is not going to be a “game” per se. It is going to be some form of augmented reality – perhaps looking like a more robust and sophisticated version of Second Life. (As a side note, if you’d like a preview of the bizarre and depressing world we could be living in once the metaverse gets rolling, take a look at the documentary Life 2.0 that covers people playing Second Life). But the concepts we covered in our play-to-earn gaming article as well as our gaming NFT article are very relevant to the metaverse.
In those articles, we discussed how the 1) function of each NFT and 2) nature/activity in which the NFT is used will both significantly affect how they are taxed. First, we asked you to imagine you had a number of different items in a game:
- “A hatchet or pickaxe that degrades over time/has a finite amount of use available to it before it needs to be replaced
- A sword or other piece of equipment that does not degrade, but becomes increasingly obsolete over time as superior versions become available
- A plot of land that you rent out/allow other users to build on
- A tavern or other piece of in-game real estate that you operate a business out of
- A limited-edition piece of art that you hang on the walls of your home in-game
All of those are NFTs within the same game, but clearly have very different use cases. Treating them all the same way would seem to miss the point and the core functionality of the asset itself.
If these were tangible assets, they would all be taxed and depreciated very differently (or not be depreciated at all). The pickaxe is not going to last more than a few months and the sword will be obsolete within a year. But on the flip side, the land, tavern, and painting will last indefinitely and – if they mirror their real-world equivalents – will likely appreciate in value.”
NFT Functionality Comes Into Play
So first, we have to look at the NFT itself and its functionality. From there, you next have to look at the surrounding activity in which the NFT is being used. Our P2E gaming article gave the examples of a child playing a video game a few hours a day vs. an adult who was spending the majority of his time working within the game:
“To illustrate, let’s use the two examples above as a starting point.
A kid raids dungeons for a few hours every weekend in his spare time. He ends up getting a pretty rare (and valuable) drop that he then sells.
That’s pretty clearly hobby income. He does this purely for his own enjoyment and the drop is an unexpected bonus, spends very little time doing this, does not rely on that income to survive, is unlikely to maintain any records surrounding the activity, etc.
That kid has to claim the dungeon drop as taxable income on his tax return (assuming he has enough income to require him to file one) and is not able to write off any in-game expenses to offset against it.
On the flip side, let’s say there’s a 50-year-old single father of five who has a blacksmithing shop in an MMORPG. He spends at least 40 hours a week grinding out weapons and armor to sell to other players.
Even though that activity is happening in-game, it is much more likely to be business income. The time commitment is much more substantial, he relies on the income to support his family, creating the weapons requires substantial investment in terms of raw materials and equipment, he is tracking all of his activity very closely to improve profitability, and this is a fairly mundane activity that he is only doing because it generates income.”
That type of situation is going to be very analogous to what people are going to be experiencing in the metaverse. You are going to have people using it for recreational activities with the same tax treatment as hobby income and personal use NFTs. But you’re also going to have people who are operating entire businesses out of it, in which case any income generated within the metaverse will be counted as business income and the NFTs taxed as business assets.
In essence, the metaverse is going to be an extension of our regular day-to-day lives. How those NFTs are being used within the metaverse will very much inform their tax treatment.
Any accounting, business, or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.
