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  1. How To Treat Costs Incurred in Creating an NFT

How To Treat Costs Incurred in Creating an NFT

Creators of NFTs will need to determine how to treat costs incurred in developing and marketing their NFTs. If a creator makes NFTs as part of a trade or business, it can generally deduct or capitalize costs for tax purposes. A taxpayer usually prefers to deduct rather than capitalize costs, as a deduction reduces the taxpayer’s tax liability for the current year while a capitalized cost is recouped over time. Subject to certain exceptions, the tax law generally requires that costs incurred in creating or enhancing a separate and distinct asset with a useful life beyond the current taxable year must be capitalized. Capitalized costs are part of an asset’s basis, and can be recovered upon a sale of the asset or, in circumstances where the asset has an identifiable useful life, by amortizing the costs over the asset’s useful life.

When considering the tax consequences of creating NFTs, creators will thus need to consider whether they are in a trade or business of creating NFTs (a factually intensive question), and if so, whether to deduct or capitalize costs incurred in creating NFTs.

Large-scale enterprises that seek to monetize existing IP via NFTs (e.g., professional sports leagues or entertainment enterprises) will need to assess how to best structure their NFT arrangements for tax purposes. For example, such enterprises must consider how to contractually integrate their existing IP into their NFT business and how to draft the terms of their NFT agreements to ensure an efficient tax result. Additionally, such enterprises must determine how to account for an array of costs that were incurred in acquiring, developing and marketing the relevant IP long before the enterprise contemplated monetizing such IP via NFTs. In many cases, potentially all of the underlying costs will have previously been claimed as deductions, while, going forward, a portion of such costs might more properly be capitalized or deferred to offset potential NFT income streams. Smaller-scale creators of NFTs will have to quickly familiarize themselves with the tax rules applicable to creators and marketers of IP.

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