The ultimate US DeFi tax guide for 2024

DeFi taxes can be complicated for investors with the intricacies of the tax code regarding DeFi and the many activities you can do on these decentralized protocols.

Transactions involving DeFi can range from earning income from staking on decentralized protocols to trading highly speculative DeFi tokens, which can be taxed in different ways.

Let’s cover how trading DeFi tokens on decentralized exchanges are taxed, taxes on staking income, DeFi lending taxes, Play-to-Earn taxes, wrapped tokens taxes, and more!

DeFi lending taxes

If you receive crypto interest from lending a loan on a DeFi protocol, you’ll have a taxable event, subject to income taxes in the US. The tax setting is similar to 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.

DeFi liquidity pool taxes in the US

Currently, there is no official guidance in the US about the tax treatment for liquidity because DeFi is still relatively new.

Are liquidity pool transfers taxed?

There are two approaches we believe the IRS may accept:

1. 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.
2. 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.

DeFi staking taxes

Staking on a DeFi exchange or protocol is a taxable event in the US, subject to income taxes, like receiving any type of staking rewards regardless of the tool you’re using.

You’ll need to track all the staking rewards you received, determine their Fair Market Value (in USD), and report it as income in your income tax return.

DeFi interest taxes

Receiving any type of interest, in the form of new coins from a DeFi protocol, is a taxable event in the US. Crypto interest is taxed at an income level in the US, with your tax rate depending on your total taxable income for the year.

As with staking, you need to determine the Fair Market Value (in USD) of all the interest you received and report it on your income tax return.

DeFi yield farming taxes

Yield farming is taxed in the US, similarly to crypto staking, despite the lack of proper guidance with DeFi taxes.

Receiving any type of interest or a percentage of the transaction fees when locking funds into a protocol is taxable.

Taxes on DeFi rewards, like governance and incentive tokens

Receiving any type of compensation in the form of rewards/new tokens, which be taxed at an income level in the US, similarly to new tokens from yield farming, staking, and crypto interest.

Taxes on margin trading, derivatives and other CFDs

Margin trading, derivatives trading, and CFDs on a crypto and DeFi environment are taxed the same at a capital gains level.

In the US, trading crypto for other crypto or FIAT using these leveraged vehicles will be taxed according to a short-term or long-term capital gains tax rate, ranging from 0% to 37%. Any crypto trading on leverage on DeFi is treated like this, similarly to doing the same trades on a centralized exchange.

Play-to-earn DeFi taxes

Earning crypto from play-to-earn games in a decentralized environment is a taxable event in the US at an income tax level.

Earning any new tokens from Web3 games is a taxable event, where you need to determine their Fair Market Value (in USD) at the time you received them and report it in your 1040 Form (income tax return).

How are wrapped tokens taxed in the US?

Currently, there is no official guidance in the US about the tax treatment of wrapped tokens. 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.

DeFi taxes on rebasing tokens

Rebasing tokens got quite popular (e.g., OlympusDAO), offering huge APYs when locking your funds for a short period, leading to a taxable event in the US.

Each time you receive new coins from staking on rebasing DAOs, you’ll have to determine its Fair Market Value (in USD) and report it as ordinary income.

Is borrowing/taking out a crypto loan taxed?

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.

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.

Are crypto loan interest payments tax deductible?

Crypto loan interest payments are not tax deductible if the loan is for personal reasons.

Examples of tax treatment for some popular DeFi platforms

Uniswap V2 & V3

On Uniswap, you can swap tokens, trade NFTs, and prove liquidity to pools. Let’s look at an example of how some of these transactions could be taxed as a suggestion.

For example, trading ETH for UNI would be a crypto-to-crypto trade, taxed at a capital gains level, with the tax rate depending on whether the investor held ETH for over 12 months or not before trading it for UNI.

Aave

With AAVE, people can lend, borrow, and earn interest on cryptocurrencies. Let’s look at how those transactions could be taxed.

If you lend crypto and earn interest or stake and earn rewards, you’d be taxed at an income level, given you’re receiving rewards for it.

If you take a crypto loan on AAVE, that’s not a taxable event in the US as a regular FIAT loan.

Compound

On Compound, investors can earn interest on their crypto holdings. In the US, earning crypto interest on a DeFi protocol like Compound is taxed at an income level as a general rule.

Investors need to determine the Fair Market Value of the interest they received and report it in their income tax return.

Maker

Maker is managing the Dai stablecoin while supporting a wide range of applications where users can borrow DAI against other crypto assets or deposit DAI and earn crypto interest as a reward.

As we’ve seen, if you receive crypto interest from depositing DAI in one of these protocols, you’d have to determine the Fair Market Value (in USD) and report that in your income tax return.

Balancer

Balancer offers liquidity pools where users can provide liquidity by adding or withdrawing crypto assets, which is a gray area in the US crypto tax code.

1inch Exchange

People can trade crypto and DeFi tokens on a DEX like 1inch Exchange, a taxable event in the US, subject to capital gains taxes.

Investors need to determine the gain/loss on each of these crypto-to-crypto trades on DEXes and report them in forms like Form 1040 and 8949.

How to report DeFi on taxes?

DeFi taxes have to be reported in different forms according to the nature of the transactions you have across DeFi exchanges and protocols.

If you have any capital gains/losses from trading DeFi tokens, you’d have to determine those, separate them from short-term and long-term, and report it on Form 8949 (schedule D) and Form 1040.

How to reduce DeFi taxes in the US?

Here are the top ways to reduce DeFi taxes in the US:

Long-Term Capital Gains

You can reduce your capital gains taxes if you hold your crypto/DeFi tokens for over 12 months before selling them for FIAT or other cryptocurrencies. A long-term capital gains tax rate ranges from 0% to 20%, while a short-term capital gains tax rate ranges from 10% to 37%.

Tax-Loss Harvesting

By harvesting losses from crypto/DeFi tokens that have lost most of their value, you can deduct that realized loss from your other capital gains and effectively reduce your crypto taxes.

IRAs & 401(k)s

Directing crypto or DeFi tokens (if available) to retirement accounts like IRAs or Roth IRAs, you can enjoy some tax benefits on your gains, reducing your crypto taxes.

Potential tax deductions & tax-free amounts

Donating crypto or DeFi tokens enables investors to claim an itemized tax deduction and reduce capital gains taxes, while, in some countries, moving to income-tax-free states can lower taxes, among other ways to reduce crypto taxes.

How to easily calculate DeFi taxes

The wide range of activities that you can do on DeFi exchanges and protocols makes it very hard to know how each of those trades are taxed and how to report them.

From income tax activities like yield farming, crypto interest, or play-to-earn games to capital gains tax scenarios like trading DeFi tokens or wrapping tokens, it is hard for investors to track all of these trades.

Use a Tax calculator for DeFi taxes

You can import all of your DeFi trades with a crypto tax calculator like CoinTracking, which will automatically track your income and gains/losses from DeFi while enabling you to generate tax reports.

DeFi Tax in other countries

Canada

Despite not having a specific guideline for DeFi, Canada taxes crypto transactions based on the type of trade you conduct, leading to income or capital gains taxes.

You can assume that if you’re earning a type of income from DeFi protocols, you’d be taxed at an income level while spending/selling any crypto would be taxed at the capital gains level. Discover more about crypto taxes in Canada.

Australia

As a general rule, in Australia, earning crypto rewards from DeFi protocol or exchange will be taxed at an income tax level, despite the lack of a guide on DeFi taxes. Read more about crypto taxes in Australia.

UK

According to the HMRC 2022 guidance, DeFi taxes in the UK will depend on the nature of the transactions. As a general rule, if you “receive income,” you’ll face income taxes in the UK, while if the transaction is seen as a “disposal,” then capital gains taxes apply. Discover more about UK crypto taxes.

Conclusion

DeFi taxes can get complicated with a variety of transactions, from earning income to having gains on decentralized exchanges.

In the US, DeFi is taxed despite its decentralization/privacy aspects, leading investors to track their gains/income across protocols/exchanges.

Crypto tax software like CoinTracking is fully prepared to track your DeFi gains/losses and income by simply pasting your blockchain/wallet address or linking your exchanges via API/CSV to import your trades. From there, investors can generate the tax reports they need to report their crypto taxes.

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.