DeFi Taxes: The Complete Guide
28 Mar, 2023 · 8 min read
DeFi taxes can get tricky due to the complexity of operations behind its emergence, but we got you covered.
Decentralized Finance opened up a brave new world for crypto traders looking at its decentralization principles, efficiency, and profit opportunities as a gateway to the future. But, as usual, you should not ignore its tax consequences.
The emergence of DeFi came primarily from the rise of decentralized exchanges (DEXes) such as Uniswap or smart-contract-based lending platforms such as AAVE. The selling point for DeFi comes from the elimination of intermediaries or a central organization managing the trading or lending between parties.
Many think that this freedom embedded in the solutions means that government organizations such as the IRS would ignore those activities. However, that’s not the case. Today, we will clarify all doubts about DeFi taxes and the key things to be aware of across different activities (e.g., token swaps, staking, liquidity pools, etc.). Follow along.
In this article:
- Are decentralized exchanges trades taxed?
- Are swap tokens taxable?
- How much is the short term capital gains tax?
- What is the long term capital gains tax rate?
- Can you deduct transaction fees from DeFi trades in your taxes?
- Does Uniswap report to the IRS?
- Is Uniswap anonymous?
- How do I report Uniswap on my taxes?
- Can the IRS track Metamask?
- Is wrapping your Bitcoin a taxable event?
- Is BTC wBTC taxable?
- Is converting to ETH2 taxable?
- Is yield farming taxable?
- Do you pay tax on a crypto loan?
- Do you pay taxes when borrowing funds from a DeFi lending tool?
- Crypto lending tax? How are crypto interest payments taxed?
- Do you pay taxes from liquidity pools (LPs)?
- The Best DeFi taxes software: CoinTracking
- Learn how you can import your DEX trades into CoinTracking to take care of your DeFi taxes
Are decentralized exchanges trades taxed?
In short, yes.
Decentralized exchanges (e.g., Uniswap, PancakeSwap, SushiSwap) make it easy and quasi-instant to swap tokens within crypto while facilitating the emergence of new tokens. However, its decentralization does not invalidate the IRS guidelines for crypto trading.
For IRS purposes in the US, a crypto-to-crypto trade is a taxable event. As a result, crypto trades that occur in a decentralized exchange are equally taxable, subject to capital gains taxes.
Are swap tokens taxable?
Decentralized protocols offer an easy and fast way to swap your tokens for another token in an environment with an intermediary/central organization. You exchange a token with another party directly. In essence, this is a crypto-to-crypto trade. In the US, all crypto-to-crypto trades are taxable events, subject to capital gains taxes. This is true whether you’re using a DEX or a centralized exchange.
As a result, you need to determine your crypto gain based on the difference between your sales proceeds and your cost basis. In the US, you need to report the gain/loss for each trade you conduct. The capital gains tax rates will depend on your holding period and other factors.
How much is the short term capital gains tax?
Now you know that DeFi trades are a taxable event, the next question is, what tax rate are you subject to? First, you need to determine your holding period. According to the IRS, your holding period starts the day after you acquired a coin.
If you then sell that same coin in 12 months or less, you’ll be subject to a short-term capital gains tax rate. The short-term capital gains tax rate can range from 10% to 37% in the US, depending on several factors (e.g., income level, filing status).
What is the long term capital gains tax rate?
If you hold your crypto for more than 12 months before selling it for a profit, you’ll be subject to a long-term capital gains tax rate. The long-term capital gains tax rate can range from 0% to 20% in the US, depending on the same factors mentioned above (e.g., income level, filing status).
CoinTracking can automatically show you which coins are eligible for a tax-privileged or tax free rate. If you’re in Germany, you can benefit from tax-free rates once you hold your crypto for more than 12 months.
Can you deduct transaction fees from DeFi trades in your taxes?
Yes, you can deduct the transaction fee (gas fee) when selling one coin for another in the US. The amount you pay for the transaction fee reduces your capital gains, resulting in a lower capital gains tax bill. Imagine that you bought 1 ETH at $1000, and then you sell the same 1 ETH for Bitcoin, but 1 ETH is now worth $3,000.
If you pay 0.1 ETH ($300) as a transaction fee, you can deduct it from the overall capital gains. In this case, you’ll have an initial capital gain of $2,000, but after deducting the fees, the gain will be reduced to $1,700. Check our guide on all the tax implications of transferring crypto between wallets.
Does Uniswap report to the IRS?
Uniswap is the most popular decentralized exchange in the market, where users can anonymously trade with each other in a crypto native environment. Currently, Uniswap is not sending any tax reports to the IRS. However, it does not mean that it will never do so.
Is Uniswap anonymous?
The IRS is indifferent if you conduct your trades in a decentralized or centralized exchange. As long as you’re trading crypto assets, the IRS will tax each one of those transactions. As a result, any swap that you do on Uniswap is a taxable event in the US. Any Uniswap trade, where you convert one crypto for another, is a taxable event, subject to capital gains taxes.
How do I report Uniswap on my taxes?
Many taxpayers in the US have been surprised with letters from the IRS, with great amounts of taxes due because they used DEXes or centralized exchanges, and they didn’t report those trades to the IRS.
As we mentioned before, you need to report each crypto-to-crypto trade you conduct, as every one of them is a taxable event. You can easily report your Uniswap trades by pasting your Ethereum address and importing your trades with a crypto taxes software like CoinTracking. Moreover, Cointracking calculates all your gains automatically and generates the necessary tax reports. For more clarification check our guide on how to report your crypto taxes.
Sign-up to CoinTracking today!
Can the IRS track Metamask?
The IRS has many ways to learn if a taxpayer has crypto holdings but is not reporting their trades according to the current tax guidelines in the US. Many taxpayers have been receiving letters from the IRS since 2019 due to not reporting their trades.
If that’s your case, Sharon Yip, the expert CPA that runs CoinTracking Full Service in the US, and her team can help you go back to the beginning of your crypto investment and help you reconcile all your crypto trades and be fully compliant. Check more details on CoinTracking full service here.
Is wrapping your Bitcoin a taxable event?
Currently, there is no official guidance in the US about the tax treatment of a crypto wrapping event. Wrapped assets became popular with the emergence of DeFi, especially to more advanced traders. From a tax perspective, wrapping an asset can be seen as a crypto to crypto trade.
Is BTC wBTC taxable?
If you convert your Bitcoin (BTC) to Wrapped Bitcoin (wBTC), most likely you’re treated as executing a crypto-to-crypto trade because you are giving up your BTC in exchange for wBTC.
Similar to other crypto-to-crypto trades, we believe that wrapping crypto is a taxable event subject to capital gains taxes in the US.
Is converting to ETH2 taxable?
If you are giving up ETH in exchange for ETH2, and you can freely sell ETH2 at a market price, then, yes, converting ETH to ETH2 is a taxable event in the US. As a result, you need to recognize a capital gain or loss for the deemed sale of ETH.
However, if your ETH2 is locked up involuntarily and you cannot sell it until a certain date, you may be able to argue that you don’t need to recognize the exchange between ETH and ETH2 until that date because you don’t have access to the ETH2 before then.
Is yield farming taxable?
Yield farming is the same as receiving staking rewards from putting your crypto to work. You’re essentially locking some of your funds in an interest-earning vehicle in a DeFi protocol.
In the US, receiving rewards from crypto staking is a taxable event, subject to income taxes. Additionally, receiving tokens from yield farming protocol is a taxable event in the US, subject to income taxes. You should report the Fair Market Value (FMV) of the interest or rewards you receive, measured in FIAT (USD). All of these rewards will go into your income tax return for the year. Find out more about crypto staking rewards and taxes here.
Do you pay tax on a crypto loan?
With DeFi, the ease of taking crypto loans became greater. Some traders take out a crypto loan due to the low-interest rates while being able to stay within the crypto ecosystem. See the difference between providing crypto loans and receiving a crypto loan from a tax perspective in the US.
Do you pay taxes when borrowing funds from a DeFi lending tool?
Crypto loans have the same tax treatment as taking a FIAT loan in the US. As a result, getting a loan is not a taxable event. Moreover, repaying a loan is also not a taxable event.
Essentially, when you receive a loan in crypto, you get a debt basis, and you don’t need to report it on your tax return.
However, if you sell some or all of the crypto you borrowed, you need to recognize a gain or loss based on the difference between your sales proceeds and your debt basis. Read more about crypto-backed loans in this complete tax guide.
Crypto lending tax? How are crypto interest payments taxed?
If you receive crypto interest from lending a loan, you’ll have a taxable event, subject to income taxes in the US. The tax setting is similar to when receiving crypto staking/yield farming rewards.
All the interest received must be reported at their Fair Market Value (in USD), while all the income received during the tax year will go into your income tax return. Find out more details on earning crypto interest and taxes.
Do you pay taxes from liquidity pools (LPs)?
Currently, there is no official guidance in the US about the tax treatment for liquidity because DeFi is still relatively new.
There are two approaches we believe the IRS may accept:
- Treat the receipt of a LP token as a taxable trade between the crypto you deposit into the liquidity pool and the LP token. A gain/loss will be recognized for the deemed sale of the crypto you put into the liquidity pool. This is an easier method when compared to the next method concerning transaction tracking and tax calculation.
- Treat the receipt of a LP token as a loan, which is not a taxable event. The rationale is you didn’t permanently lose the crypto you put into the liquidity pool. Instead, you invest your crypto in the LP for yield farming. Similarly, you didn’t obtain the LP token permanently. You need to pay it back to redeem your crypto when you exit the pool. Therefore, you can argue that the LP token works like a loan. You can use it to trade other crypto or sell it for fiat, and you have a loan basis in it, based on its FMV at the time when you first received it. However, tracking loan proceeds and loan basis in crypto tax software is very challenging. Currently, one workaround is to record the receipt of LP token as non-taxable income and the repayment of LP token as non-taxable expense in the CoinTracking software.
The Best DeFi taxes software: CoinTracking
CoinTracking covers all your DeFi needs. If you’re an active DEX trader, you can easily import all your Ethereum and Binance Smart Chain-based trades from Uniswap, 1inch Network, SushiSwap, PancakeSwap, etc.
You can simply paste your ETH or BSC address into CoinTracking and import your trades and get your gains automatically calculated. The same ETH or BSC addresses you use in TrustWallet or Metamask can be imported into CoinTracking too.
Moreover, CoinTracking can easily classify all your earnings from crypto staking, liquidity pools, earning crypto interest, and more.
Learn how you can import your DEX trades into CoinTracking to take care of your DeFi taxes:
CoinTracking can help you with more than DeFi taxes:
- Import (API & CSV) your trades from 110+ exchanges/wallets.
- Import your Binance Chain, Binance Smart Chain, and MATIC transactions.
- 25+ advanced reports, including which coins offer you a tax-free rate.
- Automatic capital Gains, according to 12 accounting methods (e.g., FIFO, LIFO, HMRC, ACB), accepted worldwide.
- Generate complete Tax Reports in your country.
If you need personalized help reviewing your trades or preparing your US tax returns, check out our CoinTracking Full Service. A team of crypto tax experts led by Sharon Yip, who helped us with this article, provides assistance for CT Full Service.
Clarify all your DeFi and crypto taxes questions:
- Do you pay taxes on crypto margin trading?
- How are rebase token protocols taxed?
- Do you pay taxes on fan tokens?
- What happens if you don’t file your crypto taxes?
- Do you pay taxes when trading stablecoins?
- How is Yield Farming Taxed?
- DeFi Taxes: The Complete Guide.
- How to save taxes with a Bitcoin IRA.
- Do you pay taxes for receiving Bitcoin tips?
- Uniswap Taxes Guide
- Is wrapping crypto taxable?
- How to calculate taxes with Bitcoin dollar-cost averaging?
- Do you pay tax on stolen, hacked, or lost crypto?
- FIFO for crypto taxes? Implications of accounting methods.
- NFT Taxes: The Complete Guide.
- Is Bitcoin taxable? The ultimate guide for 2021 taxes.
- Top crypto tax friendly countries.
- How to reduce your crypto taxes?
- Crypto tax loss harvesting: Here’s what you need to know
Disclaimer: All the information provided above is for informational purposes only and should not be considered as professional investment, legal, or tax advice. You should conduct your own research or consult with a professional financial advisor when investing.