One of the ways that you can make money with crypto is through play-to-earn games. That’s right. In some cases, you can earn cryptocurrency through gameplay.
But, how are these in-game rewards treated? Are they seen as income? How are they taxed? What happens when you move your crypto rewards out of the game and into your crypto wallet — and then sell your tokens for fiat currency?
Let’s take a look at what happens when you earn crypto while playing games on the blockchain.
How Do Crypto Games Work?
Making in-game purchases is as old as massive online gaming. Back in the day, you could make purchases in World of Warcraft to upgrade your equipment and accomplish other tasks. In Fortnite, you can purchase skins. But the profits in these types of games go straight to the developer, owner or distributor.
With a centralized, traditional game, you can also receive in-game currency. However, this in-game currency can’t be easily converted to assets outside the game. In most cases, you can’t sell the in-game currency on an exchange for fiat currency.
Crypto games, on the other hand, offer a different proposition. In addition to being able to make in-game purchases, it’s also possible to receive crypto tokens — including NFTs — as rewards for gameplay. Once you have these tokens, it’s possible to take them to an exchange and sell them for fiat currency or exchange them for other cryptocurrencies.
This is where things take a bit of a turn. Because you can exchange your play-to-earn crypto tokens for other assets, the IRS might want a cut.
What Taxes Could You Pay On Crypto Game Earnings
The IRS currently sees cryptocurrency in two ways: income and property.
First of all, as income. If you receive crypto, it’s thought of as earned income. So any rewards you receive from playing a crypto game could be seen as income. As such, it could be subject to income taxes. When determining the income, you would basically report your income as the market value of the cryptocurrency on the day you received it.
Secondly, though, crypto assets are also seen as property. IRS guidance is a bit sketchy on NFTs, so it’s unclear that they would be treated as income (but they might be). However, the property aspect is a little more cut and dry. Once you have that cryptocurrency or NFT in your possession, it’s seen as property, much like a stock.
So, your cost basis is essentially the market value of the asset when you receive it as a reward for gameplay, minus any fees you might be subject to. Later, if you decide to sell the cryptocurrency or NFT, you could be taxed based on whether it’s increased in value.
For example, let’s say you receive an NFT as an in-game reward. At the time you receive it, the market value of the NFT might be $60. Later, though, you transfer it to your crypto wallet and then put it up for sale on a marketplace. You receive $300 for it. If your fees amount to $10, that’s a profit of $230. The IRS expects to collect capital gains taxes on that amount, based on your tax bracket.
The same is true of cryptocurrency. Let’s say you earn $300 worth of cryptocurrency by playing a crypto game like Axie Infinity. You decide to sell your crypto later, after the value of your crypto rises to $800. Now, you have to report $300 of income (from the initial gain) and $500 in capital gains. (This doesn’t account for how fees might impact your overall gains.)
Of course, if the value of the cryptocurrency falls before you sell it, you could also potentially claim losses if you sell at a loss. However, you still need to report the initial reward as income. You can use any capital losses to offset some of your other capital gains or to offset your income.
What About Trading Assets In-Game?
Depending on the situation, using your crypto assets in the game could also result in taxable events. Let’s say you use cryptocurrency to buy an NFT in the game. Using that cryptocurrency is usually considered a taxable event by the IRS. So, you might need to pay taxes on the gains if the cryptocurrency gained in value since you received it. The transaction is treated as a sale of cryptocurrency to buy the NFT.
Once you buy the NFT, its cost basis is set at what you paid for it. Later, if you decide to sell the NFT in the game, or trade the NFT for some other asset, you have to consider whether you’re getting more value than what you originally paid. If your asset has appreciated in value, that’s a gain in the eyes of the IRS and you are then required to report the gain — and pay taxes.
Crypto Gaming And Figuring Out Your Taxes
Figuring your taxes with crypto gaming is tricky due to a few realities. Keeping good records is essential if you don’t want to end up in trouble with the IRS.
No Clear Guidance From The IRS
The biggest issue is that there isn’t a lot of clear guidance from the IRS. While some guidance on cryptocurrencies has been released, the decentralized finance ecosystem is developing rapidly — and regulation can’t keep up.
Additionally, while the IRS has been reasonably clear in that in-game currencies earned through games like World of Warcraft aren’t considered income, it’s different with crypto. Sure, the game might have its own currency, and you might be able to earn it by creating armor for someone else, but you can only use the currency within the game. You can create something for another player, receive in-game currency as compensation and then use that currency to buy supplies from someone else in the game.
However, with these types of games, the currency doesn’t get used outside the game. It remains in the game ecosystem. If you use fiat currency to buy in-game currency, the profits go to the game developer or owner. When you buy a skin in Fortnite, Epic Games profits.
With a crypto game, though, if you use the in-game token to buy something from someone else, the cryptocurrency goes to that player. When you receive rewards in the form of a cryptocurrency, you can actually take those coins out of the game and exchange them for another cryptocurrency — and potentially sell those tokens for fiat currency that can then be transferred to your bank account.
It’s a different ecosystem, and the IRS, with its bulky regulatory apparatus, hasn’t caught up. So the guidance is murky, and some of it might be a gray area.
Tax Records Are Scarce
As you try to figure out how to pay taxes on your crypto, it can be tough because most crypto games don’t keep track of your transactions in an easy-to-use manner.
Some crypto exchanges, like Coinbase, do help you understand your cost basis and your transaction history, which can be helpful. Most games, though, aren’t going to keep track of this for you. Trying to explain it all to the IRS can be tricky.
You can keep track of your gains and losses (and income) with the help of crypto tax software like:
Do your best to pay attention when you receive rewards, and keep up with your transactions so you have notes about the value of your crypto when you receive, buy or sell.
Keeping good records is essential whenever you’re involved with anything that results in earning an income or seeing gains due to holding assets. This is true of play-to-earn crypto games as well as buying and selling cryptocurrencies and NFTs on exchanges.
While it can be frustrating because the IRS hasn’t offered clear guidance, it’s important to plan ahead. Include your crypto in your overall financial planning and tax strategy. The last thing you need is to be forced to sell some of your appreciated crypto assets to pay your taxes — and incur even more taxes as a result.
Miranda Marquit, MBA, has been covering personal finance, investing and business topics for more than 15 years, and covering crypto topics for more than 10 years. She has contributed to numerous outlets, including NPR, Marketwatch, U.S. News & World Report and HuffPost. She is an avid podcaster, co-hosting the podcast at Money Talks News. Miranda lives in Idaho, where she enjoys spending time with her son playing board games, travel and the outdoors.