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DeFi (Decentralized Finance) Tax Services
Decentralized finance, or DeFi, allows crypto holders to lend, borrow, swap, and earn yields without traditional intermediaries. However, every action on DeFi protocols may carry a tax implication. Unlike a simple buy-and-hold of crypto, DeFi users often engage in frequent and complex transactions: providing liquidity to pools (Uniswap, SushiSwap), yield farming across platforms, borrowing against crypto collateral, receiving governance tokens, etc. Our DeFi tax service is tailored to capture and correctly report these activities. Gregory Monaco, CPA LLC has the crypto tax expertise to handle cutting-edge scenarios that many conventional tax preparers wouldn’t know how to approach.
Taxable Events in DeFi
In DeFi, the same principles apply as elsewhere: if you dispose of one asset for another, it’s a taxable event; if you earn new assets, that’s income. Some common taxable events:
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Token Swaps/Trades: Using a DEX (decentralized exchange) to swap Token A for Token B is treated like selling A for fair market value and buying B. For example, swapping ETH for DAI – you’ve “sold” ETH (triggering gain/loss) and “bought” DAI. Similarly, converting one stablecoin for another (USDC to DAI) could have a small gain/loss.
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Providing Liquidity: When you provide tokens to a liquidity pool, you often receive LP (liquidity provider) tokens in return. The IRS hasn’t explicitly ruled, but the conservative approach (and what we follow) is to treat that as disposing of your contributed tokens and receiving a new asset (the LP token) . So, if you put ETH and USDC into a pool and get LP tokens, that’s two “sales” (one for ETH, one for USDC). Often the values are equal so there’s little gain, but we check. When you withdraw your liquidity, you trade back LP tokens for potentially different amounts of ETH/USDC – that’s another disposition of LP tokens and acquisition of your coins (some of which may have changed in quantity due to impermanent loss or fees). We calculate gain/loss at both entry and exit of liquidity positions.
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Earning Interest/Rewards: If you lend crypto on a protocol (like deposit USDC on Aave, or stake in Yearn vaults), the interest or yield you earn (whether paid in the same token or a different token) is ordinary income, taxed when credited to you . For instance, if you deposit 100 DAI and later have 105 DAI, that extra 5 DAI is interest income. If the protocol pays you in another token (like COMP from Compound’s incentives), that token’s value upon distribution is income.
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Governance/Airdrop Tokens: Many DeFi users got airdrops (e.g., Uniswap’s UNI token airdrop). The value of tokens received is income . And if you later sell them, that’s a capital gain/loss relative to that basis.
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Borrowing Crypto: Merely borrowing crypto (say you deposit ETH and borrow DAI against it) is generally not taxable – you’re getting a loan, which isn’t income since you must repay. However, if the platform “pays” you in tokens for borrowing (like some yield farming strategies), those tokens are income.
Also, if your collateral gets liquidated, that’s a sale of your collateral potentially taxable (and could be messy, but we handle it case-by-case). As you can see, DeFi can trigger a mix of income and capital gains events. We help identify each and make sure nothing falls through the cracks or gets misreported.
Our DeFi Tax Reporting Offerings
Yield Farming & Lending Income:
We aggregate all forms of yield – whether it’s interest paid in kind (more of the same crypto) or reward tokens given as incentives. For each platform (Compound, Aave, Yearn, etc.), we’ll total the coins earned and determine USD values at the times of receipt. For instance, if you farmed on a platform and got weekly reward distributions of a token, we take each week’s amount × price to get your income. We include these on your tax return, typically as “Other Income” or as business income if you’re operating at a scale that’s like a trading business. We also consider deductions: while personal investment interest or expenses have limits, if your DeFi activities rise to a trade or business (rare, but possible for full-time traders), some expenses might be deductible. Usually, though, for most, it’s investment activity. We ensure compliance by acknowledging this income; many taxpayers mistakenly omit yield farming income, but the IRS is actively looking at digital asset questions.
Liquidity Pool Transactions:
These are the trickiest. We will reconstruct your ins and outs of liquidity pools. Example: You provided liquidity of 1 ETH and 3,000 USDC to a pool. At that time, ETH was $3,000, so you essentially contributed $6,000 total and got LP tokens worth $6,000. If originally that 1 ETH cost you $2,500 (basis) and the USDC basis was $3,000 (it’s stable so basis equals face value), you’d have a gain on ETH of $500 when you contributed (because disposing of ETH at $3,000 FMV) and no gain on USDC (pegged to $1). We report that. When you withdraw, say you get 0.9 ETH and 3,400 USDC (maybe ETH price moved or trading fees earned), we compare the value of LP tokens when you got them vs. what you got back. If on withdrawal your LP tokens (tracked at $6,000 initial basis) yielded assets now worth $6,200, you’d have a $200 gain. We allocate that gain among the assets received for basis purposes. It’s complex, but we do the heavy lifting. If a pool automatically reinvests fees, etc., we account for those as income too (the $400 extra USDC in the example likely came from fees – that’s income). We’ll output a clear schedule of these events for tax records.
Airdrops and Governance Tokens:
We treat airdrops/governance token allocations as income when received (even if claimed later). For example, Uniswap’s UNI airdrop in 2020 – 400 UNI at ~$3: $1,200 income. We’d then track your basis ($1,200) and if you sold later at say $10 each ($4,000 total), you have $2,800 capital gain . We’ll ensure to report the initial income and the subsequent sale correctly without double counting. If you decided not to claim an airdrop until a later date, technically IRS could argue you had constructively received it earlier; we’d argue based on when you actually took control. Each scenario can be a little different, but we lean on documented guidance and good-faith interpretations.
Overcoming DeFi Tracking Challenges
One of the hardest parts for DeFi users is tracking everything. Unlike an exchange that provides a nice 1099 or transaction history, DeFi often requires pulling data from EtherScan or other blockchain explorers, and interpreting contract interactions. We have experience and tools for this. For Ethereum-based DeFi, we use EtherScan, Zerion, or CSV exports from tools like Zapper or Dune dashboards to piece together your transaction timeline. For multi-chain DeFi (BSC, Polygon, Solana), we utilize chain-specific explorers and aggregate tools. We also rely on our understanding of common protocols: for example, knowing a Uniswap LP token address and decoding how much underlying it represents at entry/exit. We will ask you for all wallet addresses you used (don’t worry, just public addresses – we don’t need your private keys!). From that, we can pull the transactions. We maintain confidentiality and security in this process. The output is a comprehensive spreadsheet that maps crypto events to taxable events. We’ll review it with you in plain English, so you’re comfortable that we haven’t missed anything and you understand what’s being reported. This also educates you on how different actions cause taxes, which can inform your future DeFi strategies (maybe to avoid lots of short-term trades, etc., if tax is a concern).
Stay Ahead of DeFi Tax Regulations
The IRS and Treasury are catching up to DeFi. New regulations set to come into effect will require crypto brokers to report user transactions on Form 1099-DA, and proposals suggest even certain decentralized platforms might have reporting obligations. We keep an eye on these developments. By working with us now, you’ll be ahead of the curve. If new rules come that, say, identify that certain DeFi transactions are explicitly taxable in a different way, we’ll adapt our approach and can amend returns if needed to align with new guidance. We also ensure you answer that “digital assets” question on the 1040 correctly (which absolutely you must if you did DeFi trades or received income) – an incorrectly marked box could be seen as a red flag. Furthermore, as decentralized exchanges and protocols possibly start issuing tax forms or governments collaborate on monitoring, having already properly reported will keep you out of trouble. Some DeFi users might be tempted to think “It’s on-chain, IRS won’t know” – but given blockchain transparency, it’s often just a matter of time. We help you voluntarily comply now, which is the safest route.
Our DeFi tax service turns what could be a tax nightmare into a manageable process. We translate all the tech jargon and transactions into IRS-ready data, and we aim to minimize your tax liability legally in the process (for example, harvesting losses from some bad trades to offset other gains, or ensuring you claim all your expense basis in liquidity provision). With our assistance, you can continue to dive into DeFi opportunities without fear that the tax man will come calling unexpectedly.
FAQS
Q: I used a mixing service or wrapped some coins (e.g., wETH). Does that affect taxes or tracking?
A: Wrapping a coin (like converting ETH to WETH, or BTC to WBTC) is generally considered a token swap – effectively, you are trading one asset for a very similar asset, but technically it could be seen as a taxable event (ETH for WETH). Many argue it’s just a technical change and should not be taxable; however, the conservative approach is to treat it as taxable (though often no gain if value is equal at that moment). We will report it if significant. Using privacy mixers is problematic: aside from any legal issues, from a tax view you still have to report gains/losses; the difficulty is tracking basis and proceeds when coins are mixed. We strongly advise against mixing from a tax perspective because it breaks the audit trail. If it happened, we’d do our best to estimate basis for the output coins. It doesn’t exempt you from tax. We maintain compliance while respecting privacy – but remember, IRS has tools to deanonymize some mixers. So we focus on making sure income and gains are reported.
Q: My DeFi transactions are small amounts; do I really need to report every tiny yield?
A: Technically, yes. The tax law doesn’t have a de minimis exception for investment or business income (except trivial things like rounding cents). Even if you earned $10 of interest in a DeFi pool, it’s still taxable income. Now, practically, if the amounts are truly negligible, the IRS likely isn’t concerned – but as a CPA, I have to advise full reporting. We can aggregate small transactions (e.g., daily interest) into summary entries per month to keep the return neat. But we will include them. It’s in your best interest to establish a pattern of accuracy. Many small streams can add up, and also the penalties for not reporting income can be steep if discovered. So yes, even small DeFi earnings get reported. The good news: if your overall income is low, those extra dollars might not meaningfully increase your tax due (they could even fall under standard deduction or within the 0% capital gains bracket for small amounts). We’ll guide you through it and find a reasonable way to reflect the activity without drowning in paperwork (summarizing where appropriate, with detailed backup kept on file).