Have you wrapped or bridged a token during the tax year?
While wrapping and bridging tokens is becoming more popular, the IRS has not released any clear guidelines on how these transactions are taxed.
In this article, we’ll break down everything you need to know about the taxation of wrapped and bridged tokens and share different approaches to reporting these transactions on your tax return.
What is a wrapped token?
A wrapped token is a token that’s pegged to the value of an underlying cryptocurrency. Typically, it can be exchanged for the underlying cryptocurrency at any time.
Investors often use wrapped tokens if they’re interested in interacting with a blockchain that doesn’t support their existing coins.
For example, an investor may own Bitcoin but wish to interact with protocols on the Ethereum blockchain. In this case, they may exchange their Bitcoin for wrapped Bitcoin (wBTC). wBTC is designed to match the price of BTC 1:1 and can be swapped for BTC at any time.
What is token bridging?
Some investors who wish to interact with different blockchains choose to use multi-chain bridges instead of wrapped tokens. Multi-chain bridges are designed to help investors move their assets from one blockchain to another.
For example, an investor who holds ERC-20 tokens who wishes to move their assets to the Avalanche blockchain can use the Avalanche Bridge.
How are wrapped/bridged tokens taxed?
Wrapped or bridged tokens are subject to the same tax regulations as other cryptocurrencies. In the United States, crypto is considered property and can be subject to income and capital gains tax.
Income tax: If you earn cryptocurrency, you’re required to recognize ordinary income based on the fair market value of your crypto at the time you receive it. Earning crypto through staking rewards is considered income.
Capital gain tax: When you dispose of cryptocurrency, you’re required to incur a capital gain. Examples of disposal events include selling your cryptocurrency for fiat, trading your cryptocurrency for other cryptocurrencies, or making a purchase with crypto.
For more information, check out our complete guide to cryptocurrency taxes.
I wrapped a token. How is this taxed?
As discussed, swapping one cryptocurrency for another is typically considered a taxable event that requires the holder to incur a capital gain or capital loss on the coin that was disposed. However, the IRS has not released any guidance on whether wrapping and/or bridging tokens should be treated the same as a crypto-to-crypto swap.
As a result, investors report these transactions differently based on whether they wish to take an aggressive or conservative approach. We recommend taking the conservative approach, as it is more likely to hold up to future scrutiny.
Conservative approach: The conservative approach is to treat wrapping/bridging as a crypto-to-crypto swap, and report a capital gain or capital loss depending on how the price of your crypto has fluctuated since you originally received them.
Aggressive approach: The aggressive approach is to treat wrapping/bridging a token as equivalent to holding the same asset. This would not trigger a taxable event.
If you are unsure how to report your wrapped or bridged tokens, we recommend reaching out to a tax professional.
Can I claim a capital loss on a wrapped/bridged token?
Whether or not you can claim a capital loss on a wrapped/bridged token depends on which one of the approaches outlined above you choose to take. Remember, investors need to be consistent with regards to the approach they take for reporting similar transactions throughout their tax returns.
If you choose to treat wrapping and/or bridging your token as a crypto-to-crypto swap, you will be able to claim a capital loss, just as you would with any other crypto-to-crypto swap.
If you choose to treat wrapping and/or bridging as a non-taxable event, you will not be able to claim a capital loss.
How do I report fees for wrapping/bridging my token?
Gas/transaction fees for wrapping/bridging may be able to be reported on your tax return depending on what method you choose.
Individual investors, when purchasing property, are allowed to add fees to their cost basis or reduce the amount of gross proceeds from a sale when fees are directly related to buying, selling, or trading properties. However, fees are typically not tax-deductible in other circ*mstances.
As a result, it’s reasonable to assume that individual investors can only add gas fees to their cost basis or subtract it from gross proceeds when reporting wrapping and/or bridging tokens as a crypto-to-crypto swap.
However, if you’re running a cryptocurrency-related business, you’ll be able to write off gas fees related to wrapping or bridging tokens as a business expense regardless of what approach you choose to take if they are a necessary cost of running your trade or business.
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