US DeFi Tax Guide 2025

IRS Treatment of DeFi

The IRS treats DeFi transactions the same as centralized crypto transactions:

• Earning tokens = ordinary income
• Swapping tokens = capital gains/loss
• Property rules apply (crypto is property, not currency)

Yield Farming & Liquidity Mining

Tax Treatment

Earning tokens = ordinary income at fair market value when you receive control:

• Report on Form 1040, Schedule 1 (line 8z "Other Income")
• Income value = cost basis for future sales
• FMV determined when tokens become accessible

When Are Rewards "Received"?

Following IRS Revenue Ruling 2023-14 (staking guidance):

• Claimed to wallet: Taxable when you claim/harvest rewards
• Auto-compounded: Likely taxable when rewards are distributed by protocol (even if auto-reinvested)
• Vested rewards: Taxable when vesting completes

Example: Yield Farming

• March 15: Provide liquidity to Uniswap pool
• June 1: Claim 100 UNI tokens worth $600
• Income: $600 (report on Schedule 1)
• Cost basis for UNI: $600
• December 1: Sell UNI for $800
• Capital gain: $200 (report on Form 8949)

Providing Liquidity

Adding Liquidity

Not taxable if you receive LP tokens representing your deposit:

• You still own the underlying assets
• LP tokens = receipt for your deposit
• No taxable event

Removing Liquidity

Taxable if token amounts change:

• Calculate gain/loss on each token based on cost basis vs. FMV received
• Report on Form 8949

Impermanent Loss

Impermanent loss is not deductible until realized:

• While providing liquidity: no deduction
• When removing liquidity: realized loss is deductible

Example: Liquidity Pool

• Deposit: 1 ETH ($2,000) + 2,000 USDC ($2,000)
• Receive: 100 LP tokens
• Tax: $0 (not taxable)
• 6 months later, withdraw: 0.9 ETH ($2,700) + 2,100 USDC ($2,100)
• ETH: Cost basis $2,000, received $2,700 = $700 gain
• USDC: Cost basis $2,000, received $2,100 = $100 gain
• Total: $800 capital gain (short-term)

Lending & Borrowing

Lending Crypto

Interest earned = ordinary income:

• Report on Schedule 1 when received
• FMV of tokens received = income
• Cost basis = income value

Borrowing Crypto

Taking a loan = not taxable:

• Loans aren't income
• Collateral deposit = not taxable (you still own it)
• Interest paid = not deductible (personal interest)

Liquidations

Forced liquidation = taxable disposal:

• Calculate capital gain/loss on collateral seized
• Report on Form 8949

Example: Lending on Aave

• Lend 10,000 USDC (cost basis: $10,000)
• Earn 5% APY over 1 year = 500 USDC interest
• Income: $500 (report on Schedule 1)
• Cost basis for interest: $500

Example: Borrowing on Compound

• Deposit 2 ETH collateral (cost basis: $4,000)
• Borrow 3,000 USDC
• Tax: $0 (loans not taxable)
• Later: Repay 3,150 USDC (3,000 principal + 150 interest)
• Interest not deductible

Token Swaps

Every swap = taxable disposal:

• Selling token A = capital gain/loss
• Buying token B = new cost basis
• Report on Form 8949

Example: Uniswap Swap

• Buy 1 ETH for $2,000
• Swap for 2,000 DAI when ETH = $3,000
• Capital gain: $1,000
• Cost basis for DAI: $3,000

Wrapped Tokens

Conservative View (IRS Likely Position)

Wrapping = taxable disposal:

• ETH → WETH = taxable trade
• WETH → ETH = taxable trade
• Calculate gain/loss on each wrap/unwrap

Aggressive View (Some Tax Pros)

Wrapping = not taxable:

• Economic substance doctrine (no real change in value)
• Like-kind exchange (though crypto like-kind ended in 2018)
• Riskier position

⚠️ Recommendation: The IRS hasn't issued specific guidance. The conservative approach is to treat wrapping as a taxable event. Consult a crypto tax professional for your specific situation.

Airdrops & Governance Tokens

Receiving tokens = ordinary income:

• Income = FMV when you gain control
• Report on Schedule 1
• Cost basis = income value

Example: UNI Airdrop

• September 2020: Receive 400 UNI tokens
• FMV: $1,200 (400 × $3)
• Income: $1,200
• Cost basis: $1,200
• Later sell for $2,000
• Capital gain: $800

Gas Fees

Gas fees add to cost basis or reduce proceeds:

• Buying: Add gas fees to cost basis
• Selling: Subtract gas fees from proceeds
• Claiming rewards: Subtract gas fees from income (may be miscellaneous expense)

Capital Gains Tax Rates

Short-Term (≤1 year)

Long-Term (>1 year)

How to Report on Tax Return

Form 8949 (Capital Gains)

1. List each DeFi transaction (swaps, liquidity removal)
2. Include: date acquired, date sold, proceeds, cost basis, gain/loss
3. Summarize on Schedule D

Schedule 1 (Ordinary Income)

• Line 8z: Report DeFi rewards, lending interest, airdrops
• Label: "DeFi Rewards" or "Cryptocurrency Income"

Form 1040 Question

Check YES to: "At any time during 2024, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?"

• Providing liquidity = YES (you swapped/exchanged)
• Earning rewards = YES (you received)

Record Keeping

Keep records indefinitely (IRS recommends 6+ years):

• Transaction hashes
• Wallet addresses
• Timestamps and USD values
• Gas fees
• Smart contract interactions
• LP token holdings
• Protocol reward claims

Tools for DeFi Tracking

• Koinly - Best DeFi support, auto-detects yield farming
• TokenTax - Strong DeFi categorization
• CoinTracker - Good for complex DeFi portfolios

Common Mistakes

1. Not reporting DeFi rewards as income: Even small rewards must be reported
2. Forgetting to track wrapped tokens: ETH ↔ WETH may be taxable
3. Missing gas fees in calculations: Reduces your tax liability
4. Not tracking LP token basis: Need to know original deposit amounts
5. Claiming impermanent loss before realized: Must withdraw liquidity first
6. Forgetting liquidity removal creates capital gains: Token amounts usually change

FAQs

Is DeFi yield taxed as income or capital gains?

DeFi rewards are ordinary income when received, then capital gains/loss when sold.

Do I pay tax on unclaimed DeFi rewards?

Probably not until claimed, following IRS staking guidance (Revenue Ruling 2023-14). However, auto-compounded rewards may be taxable when distributed by protocol.

Are gas fees tax deductible?

Gas fees aren't directly deductible, but they increase cost basis (reducing gains) or reduce proceeds (increasing losses).

Is providing liquidity a taxable event?

Adding liquidity is generally not taxable if you receive LP tokens. Removing liquidity is taxable if token amounts change.

Do I report DeFi on Schedule C or Schedule D?

Most individual investors use Schedule D (capital gains) and Schedule 1 (income). Schedule C is for businesses/traders with trader tax status.

What if I can't afford the tax on my DeFi rewards?

You owe tax even if you don't sell. Consider:

• Selling enough rewards to cover tax
• Setting up quarterly estimated payments
• IRS payment plan if needed