With cryptocurrency developing at such a breakneck pace, it’s no surprise that tax authorities around the world have struggled to keep up at times; and for taxpayers, there are questions about how the most recent crypto innovations should be treated for tax purposes.
Two innovations that have seen massive adoption in the last year are decentralized finance (DeFi) and non-fungible tokens (NFT). DeFi encompasses an entire ecosystem of decentralized finance tools and applications, with cutting-edge techniques including fast loans Y yield farming. NFTs are cryptographically unique tokens linked to digital content, including art and music; some NFTs have been sold for astronomical sums.
Fortunately, the broad outlines of how cryptocurrencies are taxed in the US are pretty straightforward. Crypto is treated like property in the US, not a currency, similar to a stock or rental property. Depending on how cryptocurrencies are acquired or disposed of, they will be subject to Capital Gains Tax and Income Tax.
Here is the basic principle. If you earn crypto, it is subject to income tax. If you sell, trade, or spend crypto, you are subject to capital gains tax. Although much of the tax guidance on cryptocurrency trading and investment is applicable to activities in DeFi and NFT, there are also some novel or nuanced cases.
Before you can get to grips with your DeFi and NFT taxes, you will need to get your crypto accounts in order. Wearing by koinly crypto tax software, you can quickly generate crypto tax reports, import data directly from the ledger, and sync your trading history with a single click, saving valuable time you’ll need to address key questions about your DeFi and NFT activities.
Decentralized exchanges like uniswap allows you to “trade” tokens, a practice that is indistinguishable from buying and selling cryptocurrencies on centralized exchanges like Coinbase. So the same rules apply there: You pay capital gains on income, and losses count as a capital loss against your overall tax burden.
Lending in DeFi
As in traditional finance, there are no taxes on borrowed crypto capital.
That means you can guarantee your crypto assets like Ethereal on loan platforms and withdraw funds tax-free. And you can use that capital to do whatever you want, of course.
Token lending in DeFi
The loans themselves are tax-free, but what you get from the loans is taxable and varies.
If you lend crypto to a lending protocol like Aave, you will receive tokens in return, as a form of interest payment. The tokens will be subject to income tax, just like the tax on regular interest earnings from loans in traditional finance. This is because they are additional tokens that you receive in your wallet.
But some DeFi protocols do not issue individual tokens. Instead, they issue tokens that generate performance. Investors in the liquidity protocol owned by the OlympusDAO protocol hold swOHM, which remains constant in amount but increases in value over time. Tokens like these are subject to capital gains tax.
Stake tokens in DeFi
Staking involves pledging crypto assets to the network to help the blockchain validate transactions. Proof-of-stake networks like Ethereum 2.0, Polkadot, and Cardano will reward you with crypto for staking your coins – you get ETH for locking up your ETH.
Staking is one of the ambiguous areas of US crypto tax practice.
The tax treatment of participation has been considered similar to obtaining interest, therefore, Income Tax. But there is a ongoing court battle involving a Tezos-Participation partner arguing that participation is similar to manufacturing and should be subject to capital gains tax in the provision. How you decide to report it is up to you and your tax accountant.
Pay interest in DeFi
Cryptocurrency interest payments are subject to capital gains tax, which means they would count as investment expenses and would therefore be tax deductible. This is assuming that you borrowed in the normal way without further complications that would change the state.
Earn tokens in DeFi
There are many ways to earn tokens in DeFi. These include:
Earnings from these activities are subject to Income Tax. But remember: it’s the winner party that impacts tax status – not the acquisition of goods associated with these activities. You can buy the government token COMP from Compound on the market and trade it, which is subject to capital gains tax. But if you earn COMP as a result of your provision of liquidity in the Compound vaults, your COMP earnings will be subject to income tax.
DeFi Liquidity Pools
Liquidity funds are smart contracts in which crypto assets are locked up to provide funds for DeFi activities such as lending, lending, and trading. Investors provide liquidity to receive rewards, such as fee shares collected by a liquidity pool as people use them.
DeFi protocols will generally issue LP tokens that represent their share of the pool. When you decide to leave the pool, you can redeem LP tokens to receive your rewards or losses, as liquidity pools are prone to temporary losses.
The tax treatment of liquidity funds is not clear given the complexity of the structure; after all, there is no equivalent in traditional finance.
A common tax approach is to treat the liquidity pool’s activities as crypto-to-crypto trading, so the change in its liquidity position from entry to exit will be subject to capital gains tax.
Purchase of NFTs
In principle, you do not pay taxes to buy NFTs, just like you do not pay taxes to buy fungible tokens like Shiba Inu (SHIB). But What you buy them matters a lot.
If you buy NFTs with Ethereumas is standard in NFT markets like OpenSea, you will then have to pay capital gains tax on ETH you have scrapped.
There are no taxes if your purchase is made with fiat currencies such as USD.
“Flip JPEGs”, as NFT traders call it, can be a gainful activity. But selling NFTs for profit, often on secondary markets like OpenSea, is subject to capital gains tax, regardless of the asset or currency you receive in exchange: ETH, USDC, or even fiat currencies.
Remember the principle: crypto-to-crypto trading (for example, selling ETH for WBTC) is generally taxable. The fiat conversion is not necessary to trigger a taxable event. So NFTs are no exception in this regard.
Coin/create your own NFT:
Minting as a term can seem confusing because it is used in two senses in cryptography. It refers to both generating tokens and being the first buyer of a token. For tax purposes, the latter is the same as buying, as explained above.
Minting in the first sense: creating an NFT—it is tax-free. It is simply entering a data entry into the public ledger known as the blockchain, so there is no taxable event. But minting costs gas fees, so you may want to add expenses to your cost base.
Sell an NFT you created
Some people mint NFTs for the sake of it, or to turn their photos into hexagon profile pics On twitter. But for many others, minting an NFT is the first step to selling.
The sale of an NFT that you have created is subject to income tax. This is different from selling NFTs created by others on secondary markets, which are subject to capital gains tax.
Although it may be clear what What you need to do to file your DeFi and NFT taxes, with so many moving parts and nuances to consider, the practicalities of doing so can be complex. One solution is to use crypto tax software like koinly streamline the process; by automatically importing details of your NFT transactions, as well as your proceedings in DEX What uniswap Y pancake swapcan generate a complete tax report in seconds.