Crypto Investors In The U.S. Need To Be Aware Of The Tax Requirements For Each Type Of Currency Dealing

Crypto Investors In The U.S. Need To Be Aware Of The Tax Requirements For Each Type Of Currency Dealing

DEFI stands for Decentralized Finance. It refers to tools, resources, and platforms that allow any person access to financial services that exclude all third parties. It creates a permissionless and transparent, open-source financial system through the use of blockchain technology.

Position Advice

DEFI users have no choice but to take tax positions on new financial constructs of which the IRS is unaware of or which they do not, as yet, understand. Therefore DEFI users must acquire a crypto tax tool to deploy tactics and file subsequent positions they can reasonably justify.

Justifiable Positions On Crypto Transactions

Ethereum And Staking:

Conversion Of ETH Into WETH

When you convert ETH into WETH, most likely, no taxable event is triggered. The intention behind the conversion is to make it possible for ETH to trade directly with other ERC20 tokens. The prices of ETH and WETH are almost identical. No capital gain or loss exists because there is no permanent withdrawal of the property from the user of the WETH (disposition).

Spend ETH

When you spend ETH on gasoline, for example, you dispose of property to cover a fee, so yes, a taxable event is triggered. If there is a difference between the cost basis (ETH) and the FMV at the time that you pay for the gas, there is no capital gain or loss.

Deposit ETH Into A Staking Contract

When you deposit ETH into a staking contract, no taxable event happens. A taxable event is only triggered when you dispose of ETH. Therefore this is not a taxable disposition because you can get your ETH back

Upgrade ETH1 To ETH2

This type of migration is considered a token swap, which is non-taxable (like a token swap of Sai to Dai). One of the reasons for this position is the fact that ETH2 tokens replace the ETH1 tokens on a 1-1 basis, assuming you have access to ETH2 tokens afterward and not to ETH1 tokens which are no longer valid.

Stablecoins

Convert CHAI To DAI

Chai is an ERC-20 token, which allows you to earn interest on DAI without requiring it to be locked in the Maker Dai Savings Contract. The following positions require your consideration:

Position One

In terms of IRS Notice, 2014-21, cryptocurrencies are treated as property. Hence, the disposition of Dai into Chai can be seen as the disposition of one property to gain access to another. Any difference between the prices of the CHAI and the DAI is a taxable gain or loss.

Position Two

CHAI and DAI are stable coins that do not work as speculative assets initially designed to work like traditional money. The IRS has not provided any guidance for stable coins. Hence, arguably small price deferrals at conversions should not be taxable as a capital gain (or loss).

Position Three

It is possible to treat the DAI to CHAI as a deposit into the DAI savings rate with no tax event.

In all three situations above, interest earnings in CHAI may be treated as either interest income or rental income.

Liquidity Pools

ADD Liquidity To Uniswap

Position One

This is not taxable, since you are not disposing of your property, but only depositing some tokens. The UNISWAP tokens merely represent your original deposit ratio. It is not a new property.

Position Two

It is taxable since you are arguably selling your initial deposit in exchange for new property, i.e., Uniswap token. All crypto-to-crypto trades are taxable.

Earn Fees On Uniswap

Uniswap charges a 0.3% transfer fee to swappers, and this is split among the pool’s liquidity providers. In terms of the staking rules, the fees can be taxed as interest income or rental income.

Trading On Uniswap

All crypto exchanges are taxable. Your gain or loss is the difference between the FMV of the property you received and the cost basis in the virtual currency you exchanged.

Changes In Liquidity Ratio

Whenever your deposit ratio changes, you gain or lose access to one side of your pair. It can be argued that you sell one side of the pair in exchange for the other side, which is a crypto-to-crypto exchange. Whenever the ratio changes, a taxable event occurs. In real-time, this is impossible to track. The rate changes continuously. The alternative is to tax when you remove your deposit.

Removing Liquidity

As mentioned, the option is to tax when you remove your position from the pool. This can be seen as a mark-to-market approach. You can, therefore, compare the cost basis of the ETH when you entered them into the liquidity pool with the FMV when you retrieved them. The difference can be taxed as capital gain or loss.

Sets

Taxation Of Sets And ETFs

ETFs and stocks are typically taxed in the same manner. In terms of SEC regulation, ETFs are exchange-traded investment products. They must be registered with the SEC under the 1940 Act as an open-ended investment company (fund) or a unit investment trust. Sets are not registered with the SEC. Therefore, sets are not ETFs despite the many similarities. Hence it is reasonable to conclude that when you trade sets, the taxation is similar to selling the underlying asset – which will result in capital gains and losses.

DEFI Interest And Payments

Deductibility

The IRC definition does not resemble DEFI platforms. Traditional interest income is derived from lending money and not from the property. As a result, it could be argued that DEFI interest is not ‘interest’ for tax purposes.

Consequently, DEFI interest can be classified as rental income for tax purposes. Gross income includes rental received or accrued for the occupancy of real estate or the use of personal property. Personal property is any property that is not real property. Because crypto is treated as property, rewards you earn on DEFI platforms should most likely be classified as rental income.

Rental income can be offset against rental expenses. No deductions against regular interest are possible. Rental expenses include the costs of maintaining a node and interest expenses on a maker loan.

Streaming Tokens With sablier

For a payee, the taxable event occurs when tokens are received in exchange for a product or service provided. The amount to be recognized is the fair market value of the tokens at the time of receipt. When there is no liquidity or determinable market value, the fair market value is equal to the fair market value of the property or service exchanged for the cryptocurrency when the transaction takes place.

For the payer, a capital gains or loss event takes place when tokens are paid to the payee. If the payer is a business, it gets a deduction equivalent to the FMV of the tokens streamed to each employee or contractor. This is categorized as wages or contractor expenses on the books and in the tax return.

Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.

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