Ask the Crypto Tax Lawyer: Are Play-to-Earn Games Taxable?

Disclaimer: This article is not investment advice, tax advice, or legal advice. It is for informational and promotional purposes only. Do not take any action (including investments) until you have consulted with a professional about your specific situation.

At the end of 2021, Ubisoft announced its plans to add NFTs (Non-fungible Tokens) into Ghost Recon: Breakpoint. Players’ in-game weapons, vehicles, and other rewards will be tradable and sellable on a secondary market, adding a real-world value component to the game. Ubisoft will become the first mainstream videogame developer to incorporate NFTs into its video games, although other A-list developers like SquareEnix are also planning to transcend the virtual and real worlds through blockchain technology.

Ubisoft follows in the wake of some popular Play-to-Earn (P2E) games like the global sensation Axie Infinity. According to a January Business Insider article describing the P2E crypto gaming model, Axie Infinity increased the value of its native AXS cryptocurrency (an Ethereum token) by a staggering 18,000% in 2021. Metaverse platforms that promise fully functional virtual worlds in the near future like Decentraland and Sandbox also saw explosive growth. For example, Decentraland’s native MANA token increased in value by 4000%. The main draw of these virtual worlds is that they allow users all over the world to earn cryptocurrency and NFTs that tradable for mainstream crypto or fiat money. Obviously, the returns and growth potential have captured the attention of many.

However, real world earnings mean real world taxes. As crypto and NFT earnings become more and more mainstream, more tax payers will have to consider the tax implications of cryptocurrency. The IRS considers cryptocurrency to be property, which is subject to capital gains tax similar to stocks or bonds. While the IRS has had guidance on cryptocurrency transactions since 2014, NFTs are a much more recent phenomenon without official guidance. Which then creates a number of questions for P2E players about how their winnings are reported and taxed.

Do I owe taxes on my play-to-earn winnings?

Absolutely. Because play-to-earn games allow users to earn cryptocurrency or NFTs, which then can be exchanged for fiat currency (e.g. U.S. Dollars), these earnings are considered income. In general, real world earnings mean real world taxes; however, the way your earnings are taxed will depend on several different variables.

To understand how the IRS will tax play-to-earn gains, you must first apply a few basics:

Are all P2E earnings the same?

No. Although both cryptocurrency and NFTs exist on the blockchain, they are two very different things and have different tax implications. Non-fungible tokens or NFTs are unique digital-only objects or unique digital versions of real-world objects. This is basically computer code. Mostly associated with collectibles and art, NFTs use blockchain technology like cryptocurrency but can represent almost anything, including virtual real estate, in-game vehicles or weapons, and personalized avatars. In the case of Ubisoft’s Ghost Recon, the “in-game earnings” will be in the form of NFTs. Similarly, the Pokémon-like Axie creatures that players acquire in Axie Infinity are also NFTs. These in-game items are pieces of unique computer code stored on the blockchain. These NFTs can later be exchanged for other NFTs or cryptocurrency.

Cryptocurrency, however, is not a unique collectible, but rather, a virtual currency. The IRS, in its Frequently Asked Questions on Virtual Currency Transactions, defines crypto as a type of virtual currency or “a digital representation of value, other than a representation of the U.S. dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of value, and a medium of exchange.” Play to Earn games like Axie Infinity will commonly use crypto. In fact, Axie Infinity, much like Decentraland (which is more of a general attempt at a metaverse, rather than a stand-alone game), developed its own crypto token (AXS). AXS is tradable and exhcnagable into more mainstream currencies like Bitcoin or Ethereum (which are easily convertible into fiat), giving them value – not only within the game sphere itself – but also within the real world.

How do P2E gamers make money?

To fully understand taxes, it is first important to understand the basics of the P2E economy. Play-to-earn games give players an opportunity to win both cryptocurrency and NFTs by playing a game. Most often, the game will use its own native token as an in-game currency. The in-game currency and NFTs have value on the secondary trading market. To use Axie Infinity as an example, a player can earn value in several different ways:

  • First, a player acquires NFTs known as SLPs (Smooth Love Potions) through monster battles, player versus player fights, or by completing daily missions and quests. The player can then exchange those potions for cryptocurrency or even cash by selling them on an NFT exchange or DEX.
  • Second, a player can use SLPs to breed rare magical creatures (NFTs) known as Axie. Depending on the Axie’s traits and characteristics, an Axie NFT can fetch $200 or more on the secondary market.
  • Third, a player can stake AXS tokens in exchange for a particular return rate. Staking with crypto tokens is akin to holding money in a certificate of deposit (albeit, much riskier).
  • Finally, the game may award tokens or NFTs via airdrops. Airdrops are giveaways that the game may send its players as part of random promotions or in return for doing specific tasks.

What (and how) the game pays the player determines the type of taxes that particular player will owe. Is the income in the form on an NFT? Tokens? Staking income? An airdrop?

Are there taxes on tokens?

Whether it is called a token, cryptocurrency, or virtual currency, a native game token is taxed like intangible property and is subject to capital gains tax. The IRS has had a consistent position on this since at least 2014. When you purchase cryptocurrency or tokens with fiat currency (e.g. U.S. Dollars) you do not pay tax on the transaction. So if you buy AXS directly for USD, this is not a taxable transaction. However, if you buy AXS for ETH or BTC or another cryptocurrency, stablecoin, or token, you have incurred capital gains because the IRS considers you to have sold cryptocurrency you have traded – even if the transaction is a direct exchange.

If you earn crypto tokens as a part of a Play-to-Earn game, the value of such crypto is taxable as ordinary income. Likewise, when you sell crypto tokens on an exchange, you are taxed on the gain (if any) just like you would be if you sold a stock or investment real estate. Again, when you exchange one cryptocurrency for another (for example, you buy AXS with stablecoin) the exchange is taxable. Accordingly, it is critical to keep accurate and clear records of every transaction involving cryptocurrency, regardless of gain or loss.

How are NFTs taxed?

The IRS has not issued definitive guidance on how NFTs will be taxed, but most experts agree that NFTs will probably be considered property like cryptocurrency and be subject to capital gains tax. When applying this framework, NFT investing generally involves three different taxable events:

  • The Purchase of a NFT with Crytpocurrency. Play-to-Earn games often require a buy-in. Axie Infinity, for example, requires players to buy three Axies to start, which currently costs around $1,500. If you “buy-in” with cryptocurrency like ETH, the IRS will consider you having sold the ETH and have earned income equal to the difference between your purchase value and sale value. The acquisition of the NFT itself is not taxable for the buyer – but, is taxable for the seller as income.
  • The Sale of the NFT in exchange for Crypto. Selling an NFT creates a taxable capital gain or loss equal to the difference between purchase and sale price. Simply put, if you bought an NFT for $1,500 and sold it for $2,000, you incurred a $500 gain. If you bought the NFT for $1,500, but sold it for a $1,000, you have a $500 loss that you can use to reduce your other capital gains or even your ordinary income up to a certain amount.
  • The Exchange of the Crypto proceeds for U.S. Dollars or other fiat currency. Like the sale and purchase of NFTs, the exchange of a cryptocurrency into USD or other fiat currency will also trigger a taxable capital gain or loss depending on the difference between the original purchase price of the cryptocurrency (or token) and the price at the time of its sale.

Currently, there are no tax exemptions or safe-harbor periods that allow traders avoid capital gains tax on exchange type transactions.

Are NFT investors taxed differently than NFT creators?

Yes. Let’s say you’ve found a way to farm massive amounts of SLP (Smooth Love Potions) in Axie; these are NFTs. The initial creation or the minting of the NFT is not a taxable event. However, the sale of the NFT is taxable. However, in this case, since you are the creator and also the seller, and you technically “did the work” to earn the NFT, the IRS will likely consider the proceeds from your NFT sale ordinary income for tax purposes.

Is staking taxable?

Yes. Sure, my staked sheep in Wolf Game owe a 20% tax to wolves on all sheered WOOL; everyone knows that. But do I also have to pay WOOL taxes to the US government? Yes. Many taxpayers currently consider staking the same as crypto mining income, which means they will owe taxes on the fair market value of the WOOL the moment they receive the WOOL in their wallet – not just when they sell it.

The IRS is currently in litigation regarding this issue. The question being considered is whether the cryptocurrency or token has taxable value at the time of minting ( in my case “shearing”) or whether it should be taxed only upon sale of the WOOL – similar to the way traditional manufacturing companies operate. (For example, factory owners don’t pay income tax on a manufactured table, even though that manufactured table holds value, until the table sells.) This is one of the many unanswered questions in the blockchain sphere that regulators are catching up to answer.

Are Airdrops Taxable?

Yes, generally airdrops are considered ordinary income based on the fair market value of the drop at the time you get it. As with everything else, crypto-related, be sure to keep detailed records of all your crypto transactions to make sure that you account for them properly.

So, Do I Owe US Taxes on My Earnings from Play to Earn Games?

Yes. Real world earnings mean real world taxes. Whether you earn NFTs, native tokens, or Bitcoin, those assets have value and therefore subject to income tax. You, as the taxpayer, are still obligated to report income just like you would be if the game paid you in stock. As always, it is important to consult a crypto tax expert to see how the specifics of your situation apply to current IRS guidelines.

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