Reporting yield farming rewards on your tax return can be difficult.
Since DeFi protocols do not provide users with tax forms, trying to gather the information you need to fill out your tax return can take weeks.
In this guide, we’re going to break down everything you need to know about yield farming taxation. We also share a simple strategy that can help you file your DeFi and crypto taxes in minutes.
What is yield farming?
Yield farming generally refers to maximizing the rewards or returns you receive in return for providing liquidity for decentralized finance applications.
How is DeFi taxed?
At this time, the IRS has not provided any explicit guidance on taxing DeFi protocols. Tax professionals therefore rely on existing ones Tax advice for cryptocurrencies to determine how DeFi is taxed. It is reasonable to assume that:
- Crypto-to-crypto trades and other cryptocurrency disposals are subject to capital gains tax
- Earning cryptocurrency is subject to income tax
There is no tax for simply holding your cryptocurrency or Transfer your crypto between wallets You own.
For more information see our complete guide to taxing DeFi.
How is yield farming taxed?
It is reasonable to assume that yield farming may be subject to income tax and Capital Gains Tax depending on the specifics of your transactions.
Do I pay capital gains tax for yield farming?
Some yield farming transactions — such as depositing and withdrawing cryptocurrency from a liquidity pool — may be considered disposals subject to capital gains tax.
For example, Uniswap V2 allows users to contribute cryptocurrency to liquidity pools and earn rewards. In this case you are required to swap/exchange your cryptocurrency for an underlying LP token to earn rewards.
There is a likelihood that the following events will be considered disposals of your crypto and therefore subject to capital gains tax:
- Exchange your cryptocurrency for LP tokens: In this case, you will suffer a capital gain or loss depending on how the price of your cryptos that you hold as liquidity has changed since you originally received them.
- Redeem your LP tokens for your cryptocurrency: You recognize a capital gain based on how the value of your LP tokens has changed since you originally received them. In this case, your capital gain should include the value of the crypto you received as a reward.
Other examples of disposals subject to capital gains tax include:
- Sell your cryptocurrency
- Exchange your cryptocurrency for another cryptocurrency
- Use your cryptocurrency to make a purchase
It is important to note that taxing DeFi and related transactions is an evolving area that does not yet have explicit guidance from the IRS. You should consult a Cryptocurrency tax professionall with specific questions about your situation.
Do I pay income tax for yield farming?
If you earn cryptocurrency without trading your existing holdings, your yield farming rewards are more likely to be subject to income tax.
For example protocols like Manufacturer Give users DAI in exchange for providing liquidity. In this case it is you not required to trade/exchange your cryptocurrency to earn rewards. As a result, your rewards are subject to income tax based on the fair market value of your crypto at the time you receive them.
Other examples of cryptocurrency income include:
- Staking Rewards
- interest premiums
- Referral Bonuses
It is important to remember that if you dispose of the cryptocurrency you received as income, you will be subject to capital gains tax based on how the price of your rewards has changed since you originally received them.
Where do I report my yield farming taxes?
Capital gains and losses from cryptocurrency and other assets should be reported Form 8949.
Cryptocurrency earnings from DeFi protocols should be reported as “Other Income”. Attachment 1 to Form 1040.
How do I track my yield farming/liquidity mining transactions for tax purposes?
In order to report your transactions on your tax return, you must keep a record of the following information.
- A description of the cryptocurrency you are selling
- The date you originally purchased the cryptocurrency
- The date you sold or disposed of the cryptocurrency
- Proceeds from the sale of cryptocurrencies
- Your cost basis for buying cryptocurrency
- your gain or loss
It can be difficult to track this information manually. Happily, crypto control software how CoinLedger can help. The platform can connect to your Ethereum wallet, pull your transactions off the blockchain, and calculate your capital gains, losses, and income!
Create a free account and join the 300,000+ investors worldwide using CoinLedger to take the stress out of tax season.
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frequently asked Questions
Do you pay taxes on yield farming?
Yes. Depending on the specific mechanics of the DeFi protocol you are using, there will be capital gains and/or income taxes.
Are liquidity pools taxed?
Both depositing and withdrawing cryptocurrency from a liquidity pool are likely to be subject to capital gains tax.
Can the IRS Track DeFi Transactions?
DeFi transactions on blockchains like Ethereum are publicly visible and permanent. In the past that IRS has worked with contractors like Chainalysis to analyze the blockchain and take action against tax fraud.
How are rebase logs taxed?
Rebase log rewards are likely to be considered income at the time of receipt. For more information, see our blog about rebase protocol controls.
What is the best tax calculator for DeFi?
CoinLedger can automatically connect to wallets such as MetaMask and pull your DeFi transactions directly from the blockchain.
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