Dear Bankless Nation,
It’s tax season!
2020 got pretty wild with BTC crossing ATHs, ETH pumping to triple digit percentages, and DeFi season making people some serious cash. Unfortunately, now it’s time to pay up on all those gains.
While most of us don’t like doing taxes, for all of us residing in the U.S., it’s necessary. Not paying your taxes will not go over well in the long run. The IRS is paying attention.
The good thing is that they recently extended the U.S. tax deadline to May 17th, so for those still scrambling to file your crypto taxes, you have a bit more time to get it done.
This post is dedicated for all you tax procrastinators (I’m one of them).
So we brought in our friends from TokenTax to show us how to do our crypto taxes, tips on how to minimize our bill, and the things we should look out for.
It’s tax season baby.
Let’s get excited.
P.S. Ryan’s on Spring Break for the rest of the week! Buckle up, I’m running the ship till he gets back :)
P.P.S. Bankless Premium Members! Make sure you claim your Bankless Badge so you can participate in cool stuff like this raffle to win a Crypterior NFT. Last day to register!
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The Founder of dYdX and CEO of StarkWare share how they’re working together to scale DeFi.
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TokenTax’s Intro to DeFi Taxes
2020 was a great year for decentralized finance (DeFi). New protocols, growing volumes, and a surge in more sophisticated investment strategies like yield farming and flash loans generated much excitement in the space.
However, with growing interest in DeFi comes growing scrutiny from tax agencies. It’s more important than ever to accurately report activities—and to choose reporting strategies that will be the most friendly to your portfolio.
Doing so is no easy task, but it can be accomplished, typically with the aid of crypto tax software like TokenTax and/or in-the-know accountants. Read on for the basics of strategically filing taxes on your DeFi activity.
Note that the IRS and other countries’ tax authorities have not given specific guidance for DeFi taxes, so this article builds on existing crypto tax guidance for its recommendations.
Goal: Get your crypto taxes done
Effort: A few hours or days
ROI: Saving yourself from unwanted letters from the IRS and other tax agencies
How is crypto taxed?
In the United States and in many other countries, crypto assets are taxed as property. Under this guidance, investors realize a capital gain or loss on crypto whenever you sell or exchange it for another crypto asset
Crypto income is taxed too — though a bit differently than traditional capital gains. Income can be from many things, like yield farming, earning interest, staking, or being paid in crypto for work.
If someone pays you for services rendered .5 ETH and ETH is $800 each, you will have earned $400 of taxable income. Similarly, profits from yield farming are taxed as self-employment or business income, depending on the situation.
DeFi-Specific Taxable Events
While this might be confusing given all of the income-earning opportunities in DeFi today, we outline a few common DeFi tax situations below:
Liquidity pools: Although the specifics vary by protocol, broadly speaking there are two ways income from liquidity pools can be taxed. If you’re receiving crypto as interest directly on an underlying asset, and can see your wallet balance increase, it is taxed as ordinary income tax. If instead your balance of LPTs remains constant, but their value increases because of the accrual of interest due to demand or fees, your income is taxed as capital gains when you exit the pool.
DeFi governance and incentive tokens: If you receive tokens as a reward for using a DeFi platform, these are taxed as income. If you later sell them, any change in value will be taxed as a capital gain or loss.
Using wrapped assets: The IRS has not issued guidance on minting DeFi currency, such as converting ETH to wETH or converting tokenized assets into cTokens or aTokens. This has created ambiguity about how it should be treated on tax returns. While it’s possible that these conversions not be considered a taxable event, it is also possible that it would be considered an exchange, and thus realize capital gains or losses. For this reason, TokenTax’s software treats these transactions as taxable events, but functionality is coming to allow flexibility to take a different approach. Talk to a CPA for more guidance on this issue.
Interest income: If you lend your crypto or contribute it to a platform that supplies loans of crypto, you will be liable for taxation on interest earned. Whether this lending income is treated as ordinary income or as capital gains depends on your DeFi platform. For example: on Aave, you receive additional aTokens as interest, so this is income. On Compound, you don’t receive additional cTokens; rather, the value of your cTokens increase, so you recognize capital gain when you return your cTokens for the underlying asset.
Margin calls/liquidation sales: Any gains or losses from these situations are considered crypto sold. They will be taxed as capital gains or losses.
Other DeFi assets (TokenSets, tokenized assets): These are taxed according to typical cryptocurrency capital gain/loss treatment.
How do you file DeFi taxes?
In simplest terms, you upload your data from DeFi platforms to a crypto tax software like TokenTax by entering your ETH address(es) and all historical transaction data from centralized exchanges or otherwise. The software will then import your activity from all supported DeFi platforms, calculate your interest / lending income, and account for capital gains and losses as well as income.
Of course, this explanation smooths over a lot of more complicated minutiae; along the way, you may be asked for more details and documentation based on your individual case.
To illustrate step-by-step, we’ve outlined a sample TokenTax preparation process below.
1. Importing transaction history from exchanges
TokenTax supports every exchange through either APIs, CSVs, or manual entries. For the most popular exchanges, like Coinbase and Binance, you can upload your data automatically with an API connection. For other exchanges, you can download a CSV of your transactions and upload them from your drive. For more information on how to locate your exchange’s API key or download a CSV of your transaction history, visit our exchanges directory.
2. Importing ETH addresses
Although DeFi investing can produce a prodigious amount of transaction data to report, our proprietary API importer greatly simplifies this process. Simply go to the API import page and scroll down to the wallets section.
Click your preferred currency and enter your wallet information to import transactions.
3. Fixing missing or $0 cost basis
As you work on importing data into your TokenTax account, you may see sales of cryptocurrency with a $0 cost basis warning. This means that our system couldn’t find a matching acquisition for the asset sold or exchanged. Without this acquisition, a cost basis cannot be established. In most cases, missing cost basis means that you’re missing historical transaction data.
When a sale cannot be matched to an acquisition, TokenTax assumes a $0 cost basis for the sale. This may increase your capital gains beyond what you expect. For this reason, if you receive a missing cost basis warning, it’s important that you locate the missing information and import it. This can often be accomplished by manually adding off-exchange transactions or editing historical transactions that have been mis-categorized. We detail these processes below. For a longer list of common problems with missing data, visit our page on how to fix missing cost basis.
4. Properly categorizing transactions
Income and spending have different tax implications than normal deposits and withdrawals between your own exchanges and wallets, so it’s important to properly categorize any deposits/ withdrawals that are actually income from yield farming, or crypto spent on goods or services. You’ll need to do this by editing imported data.
Let's say you have three deposits that synced into your account from Balancer. But you know all three of those deposits were actually received from yield farming rewards; therefore, those deposits are actually income. To recategorize these entries, check the boxes next to the transactions. Then, at the top of the table, click "Edit Transaction Type," and then choose the appropriate option.
Tax Filing Tips from TokenTax
Consider taking advantage of extensions: If you haven’t started your DeFi tax prep in time, you may need to file an extension in order to have enough time to reconcile your transactions. Filing an extension and making an estimated payment will extend your tax deadline and help you to avoid late penalties and/or fees.
Set aside profit for taxes: This one is straightforward; you don’t want to be stuck owing a figure you’re not able to pay. Make sure that you’re saving enough of your profits to cover your taxes, just like you would as an independent contractor.
Harvest your tax losses: Tax loss harvesting is a tax strategy where you strategically sell off crypto that you hold at a loss to lower your capital gains. Smart investors will trigger certain capital losses, often near the end of the year, to save money on their taxes. Work with a crypto tax software or professional before the end of the tax year to implement this strategy. TokenTax, for example, offers a tax loss harvesting dashboard with all of its plans.
Deduct gas fees against income: As an individual, you cannot directly offset income with expenses. However, if you are yield farming, either through self-employment or within a business entity like an LLC or corporation, you could deduct gas fees for yield farming as business expenses. These businesses expenses would offset your income from yield farming, much like a bitcoin miner would offset their mining income with electric and equipment fees.
Fix missing cost basis issues: As outlined above, in TokenTax’s software, a missing cost basis will default to a $0 purchase price, often resulting in much higher capital gains than expected. To avoid this outcome and ensure a smoother filing process, keep and organize your crypto transaction data so that you can easily ad
With May 17 as the IRS’ extended deadline right around the corner, it’s past time to start gathering your data and thinking about your crypto tax returns. However, if you haven’t begun—or you have, but you’re struggling— contact a crypto tax software or specialist soon!
Let’s get your crypto taxes done.
File your crypto taxes
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Zac McClure is the Co-Founder of TokenTax. He started TokenTax after his career in international finance and accounting at JPMorgan, Imprint Capital and Bain. He has worked in over a half-dozen countries and received his MBA from the UPenn Wharton School.
🙏Thanks to our sponsor
Aave is a decentralised, open source and non-custodial liquidity protocol enabling users to earn interest on deposits and borrow assets. Aave Protocol is unique in that it tokenizes deposits as aTokens, which accrue interest in real time. It also pioneered Flash Loans and Credit Delegation as innovative DeFi building blocks. The Aave Protocol V2 makes the DeFi experience more seamless with features that allow you to swap your assets for the best yields on the market, and more. Check it out here.
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Not financial or tax advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This newsletter is not tax advice. Talk to your accountant. Do your own research.
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