OVERVIEW
- October, 2022 Update: The IRS has updated their tax guidelines to include NFTs as digital assets, they are to be treated the same as cryptocurrencies and stablecoins.
- The IRS has made the decision to not classify NFTs as collectibles. The IRS treats collectibles as prohibited investments in a solo 401k. Instead of investments, they’ll be treated as distributions and you’ll be hit with taxes and early distribution fees.
- Therefore, yes you can buy an NFT through a solo 401k.
With tax-free compounding and tax-free withdrawals in retirement, a solo 401k is one of the best retirement accounts to hold high-growth assets. You don’t pay any taxes when you sell assets in your account (tax-free compounding), and with the Roth solo 401k account, you pay zero taxes on when you withdraw from your account in retirement.
Like cryptocurrencies, NFTs can appreciate in value rapidly. For example, Bored Ape Yacht Club launched in April 2021 at 0.08 Ethereum, which was worth around $200. Just nine months later, each one was worth at least $290,000, an increase of around 145,000%.
If you bought several Bored Apes during the mint, like many people have, you could have made a fortune in a very short amount of time. If you put in $10,000 at launch, you would have turned it into $14.5 million in nine months. And if you purchased those Bored Apes through a solo 401k, you would essentially pay zero capital gains tax.
Can you buy an NFT through a solo 401k?
Per new IRS guidelines released in October 2022, NFTs are now treated as a digital asset, and will not be classified as a collectible. Moving forward into 2023, you can buy NFTs through your solo 401k.
Before these guidelines were released, it was still risky to hold NFTs in a retirement account like a solo 401k because:
- They fit the description of a collectible, which the IRS doesn’t allow as an investment in a solo 401k.
- The IRS has not provided any definitive guidance around how NFTs are treated.
Now that the IRS has provided clear guidelines on how NFTs will be treated, it’s safe to add them to your list of investments within your solo 401k plan.
Note: Not all solo 401k plan providers let you invest your funds into alternative assets like NFTs. Compare the best self-directed solo 401k plans here.
With a solo 401k, you’re allowed to invest in almost any type of asset class. In fact, the IRS doesn’t even have an official list of allowable investments for a solo 401k. Instead, they only have a short list of things that aren’t allowed.
Prohibited investments include:
- Collectibles like art, antiques, stamps, and rugs.
- S corporation stock.
- Life insurance investments.
Any investments made into these things will get counted as distributions, and you would have to pay early-distribution penalties and taxes. For example, if you purchase a piece of art for $1,000, the IRS would consider that as you making an early withdrawal of $1,000 in order to purchase the art, rather than counting it as an investment.
For cryptocurrencies, the IRS has officially stated that they will be treated as capital assets, and are subject to capital gains tax. With NFTs, however, the IRS has made no official decision on whether they’re an asset class or a collectible.
What are NFTs?
An NFT stands for Non-Fungible Token. Essentially, it proves ownership of a digital asset like art, music, event tickets, photography, songs, and videos. The most common type of NFT is digital art, and art is classified as a collectible by the IRS.
Examples of NFT sales:
- Jack Dorsey, founder of Twitter, sold his first tweet as an NFT for $2.9 million.
- Beeple sold his digital art piece, Everydays: The First 5000 Days, for $69 million. This is the largest NFT sale to date.
- Remember the Bored Apes we talked about earlier? The highest sale of a Bored Ape was $3.4 million.
Like art, NFTs are valued at whatever the buyer and seller agree it’s worth, and the value usually increases based on rarity and historical significance.
In April 13, 2021, IRS Commissioner Charles Rettig testified before the Senate Finance Committee and stated, “NFTs are essentially collectibles in the crypto world.” While this doesn’t count as an official IRS decision, it’s a peek into the direction they’re headed.
However, NFTs can be more than just digital art. We’re still early in the development and adoption of NFTs and their use cases in the real world. For now, the majority of NFTs exist as digital art. In the future, we’ll likely see more of a transition to real-world utility.
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