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How to Report Cryptocurrency Capital Gains and Losses From DeFi Protocols and Dapps
|Last Updated on: 29th September 2023, 10:04 am
How to Report Cryptocurrency Capital Gains and Losses From DeFi Protocols and Dapps
The world of decentralized finance (DeFi) and dapps is complex, but you still need to report capital gains and losses for tax purposes. This article will walk you through the key steps so you can accurately track and report your crypto activity.
What is DeFi?
DeFi stands for decentralized finance. It refers to financial applications built on blockchain networks that aim to provide services like borrowing, lending, trading, without relying on traditional financial institutions. Some examples of popular DeFi protocols include Uniswap, Aave, Compound, MakerDAO.
Dapps stands for decentralized applications. These are apps built on blockchain networks like Ethereum that connect users directly to providers. DeFi dapps allow you to earn interest on crypto deposits, lend and borrow crypto assets, trade tokens on a decentralized exchange, and more.
Why DeFi Activity is Taxable
The IRS treats cryptocurrencies as property for tax purposes[1]. This means any sale, exchange, or disposition of your crypto triggers a taxable event. Even if you don’t sell your crypto for fiat currency like USD, trading one crypto for another is a taxable event.
Likewise, earning rewards and interest from DeFi protocols is considered taxable income by the IRS[2]. Any crypto you receive from staking, liquidity mining, governance tokens, etc. needs to be reported.
Calculating Your Crypto Taxes
When you dispose of crypto, you need to calculate your capital gain or loss on the transaction. This is done by taking the sale price minus your cost basis.
Your cost basis is how much you paid to acquire the crypto initially. To determine your total capital gain or loss for the year, you sum up each of your taxable crypto transactions.
Short-term vs Long-term Gains
Short-term capital gains apply when you held the crypto for less than a year before selling or exchanging it. These are taxed at your ordinary income tax rate, up to 37% [3].
Long-term capital gains apply when you held the crypto for over a year before disposing of it. These have preferential tax rates between 0-20% depending on your income[3].
Wash Sales
The IRS does not allow wash sales for cryptocurrency, unlike stocks. This means if you sell crypto at a loss and rebuy it shortly after, you cannot claim the capital loss[4]. You must wait at least 31 days before repurchasing to avoid triggering the wash sale rule.
DeFi Interest & Rewards
Any interest, staking rewards, governance tokens, etc. you earn from DeFi protocols are subject to ordinary income tax rates, up to 37% [2]. Even if you don’t sell the rewards, you have to report their fair market value in USD at time of receipt.
Tracking Your DeFi Transactions
In order to accurately report your crypto taxes, you need to track and record every taxable transaction. For DeFi activity, this includes:
- Swapping tokens on a DEX like Uniswap or Pancakeswap
- Adding or removing liquidity from AMM pools
- Earning yield through staking, lending, liquidity mining
- Claiming airdrops and governance tokens
You need the date, value in USD, and any costs for each of these transactions. This data can be difficult to track manually, especially across multiple wallets and chains. That’s why using crypto tax software can help automate the process[5].
Reporting DeFi on Tax Forms
In the U.S., crypto taxes are reported on IRS Form 8949 for capital gains and losses. A separate statement gets attached listing details for each transaction. Form 1040 Schedule 1 is where you report total capital gains and losses from Form 8949[6].
For earned crypto income like staking rewards, you report this on Form 1040 Schedule 1 as “Other Income”. Make sure to note which income category it falls under, like interest, ordinary income, etc[6].
If you received over $10 in crypto rewards from a particular project, you may also need to file Form 1099-MISC. Check requirements for 1099-MISC to see if it applies to your situation.
Other DeFi Tax Tips
Here are some other tips when dealing with DeFi taxes:
- Record your cost basis for each crypto purchase
- Mark down fair market value of all rewards when received
- Keep track of ETH gas fees – these can be deducted
- If audited, have records proving your transactions
- Consider using crypto tax software to simplify the process
Taxes on crypto and DeFi can certainly be confusing. But taking the time to track your transactions and report them properly can save you big headaches down the road. Double check your tax obligations and use all the tools available to file accurately.