By Ian Berger, JD
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If you are thinking of buying an NFT (non-fungible token) with your IRA funds, you may want to reconsider. In Notice 2023-27, the IRS said that NFTs associated with “collectibles” are prohibited IRA investments. This could expose you to significant taxes and penalties.
IRAs are subject to strict prohibited transaction rules to ensure that an IRA owner (or related party) does not engage in self-dealing. But only a few IRA investments are prohibited: collectibles, life insurance and S-corporation stock.
So, what is a collectible? Under the tax code, it includes:
- Any work of art;
- Any rug or antique;
- Any metal or gem;
- Any stamp or coin (except for certain gold coins or silver coins minted by the Treasury Department, as well as certain bullion);
- Any alcoholic beverage; or
- Any other tangible personal property specified by the IRS.
Notice 2023-27 says that an NFT is itself a collectible if it is associated with any of these prohibited collectibles. This would occur if the NFT either gives the NFT holder a right to a prohibited collectible or certifies ownership of a prohibited collectible.
If an NFT is considered a collectible, then an IRA investment in the NFT is prohibited and would result in a “deemed distribution” to you in the year of your investment. (It’s called a “deemed distribution” because you don’t have to withdraw the collectible from the IRA when the distribution on the investment occurs.) The amount of the distribution is the original cost of the collectible.
If you are investing a traditional IRA in a collectible, all or part of the deemed distribution may be taxable. And if you are under age 59 ½, you may also be subject to a 10% early distribution penalty.
By contrast, if you’re investing a Roth IRA in a collectible, the deemed distribution would not be taxable if the distribution is “qualified.” To be qualified, the investment must have been made after any of your Roth IRAs has been held for at least five years and when you are at least age 59 ½. If the distribution is not qualified, the Roth IRA ordering rules apply, and all or part of the distribution may be taxed to you.
So, think carefully before making any new IRA investments in an NFT that is associated with a prohibited collectible. But what if you already have that type of investment in your IRA? Any IRA investment in NFTs made before 2020 would probably be OK since any IRS issues would be barred by the usual three-year IRS statute of limitations. However, it’s not clear whether the IRS will retroactively go after investments made after 2019 but before March 21, 2023 (the date Notice 2023-27 was issued). If you are in that boat, by all means see a CPA or tax attorney for advice.