Reporting yield farming rewards on your tax return can be difficult.
Since DeFi protocols don’t provide tax forms to users, trying to collect the information you need to fill out your tax return can take weeks of effort.
In this guide, we’ll break down everything you need to know about how yield farming is taxed. We’ll 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 yield that you receive in return for providing liquidity to Decentralized Financial applications.
How is DeFi taxed?
At this time, the IRS hasn’t provided explicit guidance on how DeFi protocols are taxed. As a result, tax professionals rely on existing cryptocurrency tax guidance to determine how DeFi is taxed. It’s reasonable to assume the following:
- Crypto-to-crypto trades and other disposals of cryptocurrency are subject to capital gains tax
- Earning cryptocurrency is subject to income tax
There is no tax for simply holding your cryptocurrency or transferring your crypto between wallets you own.
For more information, check out our complete guide to how DeFi is taxed.
How is yield farming taxed?
It’s reasonable to assume that yield farming can 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 trade/exchange your cryptocurrency for an underlying LP token to receive rewards.
There is a likelihood that the following events will be seen as disposals of your crypto, and thus will be subject to capital gains tax:
- Trading your cryptocurrency for LP tokens: In this case, you’ll incur a capital gain or loss depending on how the price of your crypto you’re depositing as liquidity has changed since you originally received them.
- Redeeming your LP tokens for your cryptocurrency: You’ll 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’ve received as a reward.
Other examples of disposals subject to capital gains tax include:
- Selling your cryptocurrency
- Trading your cryptocurrency for another crypto
- Using your cryptocurrency to make a purchase
It’s important to note that the taxability of DeFi and associated transactions is an evolving space that doesn’t have explicit guidance from the IRS yet. You should consult a cryptocurrency tax professional with specific questions regarding your situation.
Do I pay income tax for yield farming?
When you earn cryptocurrency without trading away your existing holdings, your yield farming rewards will more likely be subject to income tax.
For example, protocols like Maker give users DAI in exchange for providing liquidity. In this case, you are not required to trade/exchange your cryptocurrency to receive rewards. As a result, your rewards are subject to income tax based on the fair market value of your crypto at the time of receipt.
Other examples of cryptocurrency income include:
- Staking rewards
- Interest rewards
- Referral rewards
It’s important to remember that if you dispose of the cryptocurrency you received as income, you’ll be subject to capital gains tax based on how the price of your rewards has changed since you originally received them.
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Where do I report my yield farming taxes?
Capital gains and losses from cryptocurrency and other assets should be reported on Form 8949.
Cryptocurrency income from DeFi protocols should be reported as ‘Other Income’ on Schedule 1 of Form 1040.
How do I track my yield farming/liquidity mining transactions for tax purposes?
To report your transactions on your tax return, you’ll need to keep records of the following information.
- A description of the cryptocurrency you sold
- The date you originally acquired the cryptocurrency
- The date you sold or disposed of the cryptocurrency
- Proceeds from the cryptocurrency disposal
- Your cost basis for purchasing the cryptocurrency
- Your gain or loss
It can be difficult to track this information manually. Luckily, crypto tax software like CoinLedger can help. The platform can connect to your Ethereum wallet, pull your transactions from the blockchain, and calculate your capital gains, losses, and income!
Create a free account and join the 500,000+ investors worldwide who use CoinLedger to take the stress out of tax season.
Get started for free.
Frequently asked questions
Do you pay taxes on yield farming?
Yes. You’ll incur capital gains and/or income tax depending on the specific mechanisms of the DeFi protocol you’re using.
Are liquidity pools taxed?
It’s likely that depositing and withdrawing cryptocurrency from a liquidity pool are both 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, the IRS has worked with contractors like Chainalysis to analyze the blockchain and crack down on tax fraud.
How are rebase protocols taxed?
It’s likely that rewards from rebase protocols will be considered income at the time of receipt. For more information, check out our blog on rebase protocol taxes.
What’s the best tax calculator for DeFi?
CoinLedger can automatically connect to wallets like MetaMask and pull your DeFi transactions directly from the blockchain.
