Non-fungible tokens (NFTs) are the newest kids on the block in cryptocurrency, representing more than $23 billion in trades in 2021. While NFT investors tend to be crypto-savvy speculators, some retirement savers are starting to wonder: Can I buy NFTs in my self-directed individual retirement account (SDIRA)?
The answer is not as simple as you might think, because the Internal Revenue Service (IRS) only states what you can’t hold in an individual retirement account (IRA): life insurance and collectibles. Ultimately, it all comes down to whether the IRS decides NFTs are collectibles or something else.
Key Takeaways
- A non-fungible token (NFT) is a virtual deed that conveys ownership of a digital asset.
- By law, you can’t hold life insurance or collectibles in an individual retirement account (IRA).
- The Internal Revenue Service (IRS) has not yet provided specific guidance on whether NFTs count as collectibles, so it’s risky to hold one in your self-directed IRA (SDIRA).
- Collectibles in IRAs are treated as distributions and taxed as ordinary income for the year when you invest.
What Is a Non-Fungible Token (NFT)?
An NFT is a virtual deed that conveys ownership of a digital asset created on a blockchain network (usually Ethereum). Any digital creation—including images, GIFs, songs, videos, and designer sneakers—can be minted into an NFT. Once the content is logged on the blockchain, NFTs can be bought and sold with cryptocurrencies. Transfers and sales are recorded on chain, creating a price history and provenance ledger.
Cryptocurrencies are generally considered fungible assets, as they are interchangeable (i.e., you can exchange one bitcoin for another bitcoin and get the same thing). NFTs represent unique digital assets and are therefore non-fungible.
What Is a Self-Directed IRA (SDIRA)?
An SDIRA is much like a standard IRA, with one key distinction: Only SDIRAs let you buy alternative investments, such as real estate and cryptocurrencies.
Now, it’s not that the IRS doesn’t allow nontraditional assets in IRAs. As noted above, life insurance and collectibles are the only things that you can’t hold in any kind of IRA. However, the “big box” IRA companies (i.e., Fidelity, Schwab, and Vanguard) want you to buy their financial products, which tend to be stocks, bonds, and mutual funds, so they don’t offer the option of investing in other assets.
As not all custodians support alternative investments, you need a special SDIRA trustee or custodian that offers the nontraditional assets that you want to buy and sell.
What Can You Hold in an SDIRA?
It’s pretty clear what life insurance is, but what about collectibles? Under Internal Revenue Code Section 408(m)(2), a collectible is any:
- Work of art
- Rug or antique
- Metal or gem (with limited exceptions)
- Stamp or coin (except for coins issued under the laws of any state)
- Alcoholic beverage
- Other tangible personal property
$69 million and change
The amount that an NFT titled Everydays: The First 5000 Days by digital artist Beeple sold for at a Christie’s auction in March 2021, setting a record for digital art.
Can You Buy NFTs with Your SDIRA?
Maybe. NFTs are “a gray area,” says Dan Hunnam, former chief operating officer (COO) at ZenLedger. a cryptocurrency tax platform. “Section 408(m) of the Internal Revenue Code, which talks about intangible assets and collectibles, establishes certain things such as art, stamps, and other tangible items recognized by the government as collectibles. These items are not allowed to be purchased in an SDIRA.”
However, as the IRS hasn’t yet issued specific guidance on NFTs, nobody knows for sure if they will count as collectibles. “NFTs are digital assets that fall into, but also outside of, this category,” Hunnam says. “They can be compared to collectibles, but they are not tangible assets.”
Should You Buy NFTs with Your SDIRA?
Probably not. “The risks of holding NFTs in your SDIRA would be the same as holding any other unallowed collectible,” Hunnam says. “If you put such an item into your IRA, the IRS will consider the value of that item to be distributed to you in the tax year that you made the investment.”
Of course, that can mean taxes and penalties. “If you took a tax deduction for the contributions used to buy that item, you’ll have to pay ordinary income taxes on the distributed amount,” Hunnam says. “In addition,” he warns, “you could be subject to a 10% early distribution penalty” if you are younger than 59½ years old.
Are Non-Fungible Tokens (NFTs) Considered Collectibles?
The Internal Revenue Service (IRS) has not yet issued specific guidance, but “any work of art” is considered a collectible under Section 408(m)(2) of the Internal Revenue Code. Non-fungible tokens (NFTs) are bought with cryptocurrency, so the IRS will likely treat NFTs similarly to other crypto transactions.
Do You Have to Pay Taxes on NFTs?
Yes. While the IRS hasn’t decided if NFTs count as collectibles, it treats NFTs as investments—meaning that you could owe taxes. “It is a relatively straightforward process to calculate tax liability when buying, selling, and trading NFTs,” Hunnam says. “Swapping an NFT for another NFT or a cryptocurrency is a taxable event, [and] staking rewards or NFT-related airdrops are income.”
The Bottom Line
Until the IRS provides specific guidance, it’s best to keep your NFT assets out of your SDIRA. “We would recommend exercising caution if you’re considering holding an NFT in your SDIRA, and consider making the purchase with separate funds,” Hunnam says.