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Investing Update on Including NFTs in a Self-directed IRA: Are They Collectibles?

Published on May 1, 2023

The growing asset class has caught the attention of the IRS, which wants to tax NFTs as collectibles. If ruled as collectibles for tax purposes, this may hurt investors who wish to include these digital assets with their self-directed IRA.

While self-directed IRAs allow investors to include so many diverse types of assets in their accounts, collectibles are not among them. In fact, according to IRS guidelines, collectibles and insurance policies are the types of investments that are prohibited within self-directed IRAs.

Now, Americans’ growing interest in nonfungible tokens, or NFTs, has caught the attention of the IRS and the United States Treasury Department.

What are NFTs?

NFTs are digital assets; more specifically, each one is a unique digital identifier that certifies the authenticity and owners of a right or asset. The identifier is recorded using another relatively new platform, distributed ledger technology (blockchain is one example of this technology). The transaction is recorded, shared, and synchronized on multiple nodes on a computing network. Pretty wonky, right?

The “token” in a nonfungible token is an encoded data entry on the ledger. “Nonfungible” means the item is not easy to exchange or mix with other similar goods or assets. Due to their unique digital signatures, NFTs cannot be exchanged for or equal to one another (like trading one dollar for another dollar—same value, same terrestrial item). Hence, it stays unique and separate.

NFTs usually show up in digital artwork or photography, videos, memes, GIFs and social media posts, music, sports, gaming, and even clothing for avatars to wear in digital universes. They aren’t new, but their popularity is growing among investors, including those who self-direct their retirement plans.

What’s considered a collectible?

The term refers to works of art, rugs, antiques, metals (with exception of certain precious metals which are a popular asset within self-directed IRAs), gems, stamps, alcoholic beverages, or other tangible personal property specified by the IRS. Since nonfungible tokens are not tangible but digital, do they qualify as collectibles? That’s the big question on the table.

Is an NFT a collectible asset under tax law?

There are currently no specific guidelines about NFTs in this regard; but last month, the IRS and Treasury Department issued Notice 2023-27 to solicit feedback for guidance regarding the tax treatment of nonfungible tokens. There is a public comment period first (ending on June 19, 2023) before the agencies issue final rules about whether NFTs are considered collectibles under tax law.

At question with the IRS judge is whether the NFT’s associated right or asset is a collectible as currently defined in the tax code. If it is, the NFT is also a collectible.

For taxpayers in general, ruling that NFTs should be taxed as collectibles means individuals would pay a higher capital gains tax rate on the sale of the asset (up to 28%). For self-directed investors, this could spell the end of including these digital assets within their self-directed IRA, since collectibles comprise an excluded asset class in those retirement plans.

NFTs and Self-directed IRAs
Collectibles or not collectibles? That is the investment question.

For now, investors can include nonfungible tokens in their self-directed IRAs but the future is not yet clear. At Next Generation, we are following the matter closely and will keep our clients and website visitors apprised of any IRS final rules or guidelines about the tax treatment of NFTs. If you have questions about the types of alternative assets allowed in self-directed retirement plans, our team is here to help by email at NextGenerationTrust.com or email to NewAccounts@NextGenerationTrust.com. You can also schedule a complimentary education session with one of our self-direction experts.

Sources (FYI):