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Article

Ultimate Crypto Tax Guide

When the tax man comes calling, Bankless has you covered.
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Dec 1, 202110 min read

Dear Bankless Nation,

It’s December. Almost the end of the year.

Is anyone else going “OMG what about my taxes?”

I know some of you are tax optimizerrrrr’s like me

Or let me put it this way.

Did you do anything like this in 2021?

  • Buy or sell an NFT
  • Borrow against a token
  • Spend ETH on gas fees
  • Earn from DAO
  • Provide liquidity to a DEX

How do you figure out what you owe in taxes?

Or keep good records so you know what you’ll owe later?

Taxes suck. But so does jail. So generally we suggest you keep on top of this stuff.

Unfortunately, with the growing complexity of crypto and its new highly fluid asset class, governments have given us very little clarity on how to pay our taxes.

Idk if they even know how to tell us. We’re relying on guidance from the IRS from 2014. NFTs and DeFi didn’t exist then. Ethereum didn’t even exist!

But it’s a mistake to ignore it. We have to make the best assumptions we can.

Tax professionals have done their best to help people like you and me stay compliant.

One of those professional teams is Zenledger. Today, Dan helps us prepare for tax season, with guidance on buying/selling, gas fees, NFTs, DeFi, and DAOs as we close out the year.

We’ve focused on the U.S. for this guide but please adapt for your tax jurisdiction!

This is your comprehensive crypto tax guide for 2021.

- RSA

P.S. We worked with ZenLedger to get you 10% off your tax software for 2021. Use code ‘BANKLESS10’ at checkout :)


Guest Writer: Dan Hannum is the COO at ZenLedger. He was a buy-side analyst and portfolio manager at TD Ameritrade. He was an early crypto investor and analyst at Blockchain Capital before founding Hannum Capital Management, an advisory and venture investment firm.

All around the world, there are ongoing debates about how exactly crypto should be taxed and regulated. In the United States, there’s one basic rule that can help you frame your cryptocurrency tax expectations: the IRS considers cryptocurrency to be “property.” This means that they are taxed similar to property or stocks, in terms of capital gains/losses.

It’s also critical to understand the cost basis of your cryptocurrency. While various accounting methods are used to determine cost basis, the general goal is simple: figure out how much you spent acquiring your cryptocurrency.

The cost basis not only includes the purchase price of cryptocurrencies, but additional transaction fees, brokerage commissions, and other related costs. The cost basis is important because it is used to determine your taxable gains or losses.

Taxable vs. Non-Taxable Transactions

The first distinction is quite straightforward: find out whether there’s been a “taxable” event on your transaction. If you purchased cryptocurrencies and then decided to sell them (whether for a profit or loss), it means that it was a taxable transaction.

If you trade the crypto asset for another cryptocurrency, this is also considered a taxable event. Other taxable events include receiving cryptocurrency as a result of a hard fork or mining or using cryptocurrency to pay for goods and/or services.

There are also non-taxable transactions that crypto investors/traders may want to consider. If you decided to donate some Bitcoin to a charity, this would not be a non-taxable transaction. If you want to gift a family member or friend with Bitcoin, it would also be a non-taxable transaction. However, it should be noted that crypto taxes are necessary if the gift exceeds $15,000, a gift tax return will be necessary.

A cryptocurrency purchase using USD, to be clear, is also a non-taxable transaction. The asset is only taxed once it is sold, and it then becomes a capital gain or loss. Don't worry about transferring your assets from one crypto wallet to another: this is not a taxable event.


Get 10% off when signing up for ZenLedger. Use the code BANKLESS10!


NFT Taxes for Consumers

Here’s a range of NFT scenarios—some common, some very specific—and how they can be taxed.

1. Buying NFTs

Buying an NFT can create a capital gain, depending on how you buy it.

Using crypto to buy NFTs

Remember, buying an NFT with crypto is like selling the crypto for USD, then using USD to buy the NFT. You’ll have a capital gain or capital loss on the sale of the crypto.

Buying crypto to buy NFTs

If you’re able to purchase the NFT immediately, you may not have much or any capital gain or loss. However, the transaction should still be reported on Form 8949 even if there is no gain.

Buying NFTs with USD

Congratulations, you found a rare non-taxable event! The amount of USD you paid is your cost basis, and you’ll have a capital gain or loss if and when you sell the NFT.

2. Reselling NFTs

Like other cryptos, NFTs are considered “sold” when you sell them for USD, trade them for other tokens, or use them to buy something.

Capital Gains vs Collectibles

You may have heard that some NFTs may be considered collectibles, and therefore long-term gains from selling them are subject to a maximum 28% tax rate. However, there’s a strong argument to be made that NFTs are not collectibles since they aren’t “tangible personal property.”

For NFTs that are not collectibles, normal capital gains rules apply. Consult a tax professional if you have questions about a specific token or situation.

Trading NFTs for NFTs

Trading one NFT for another, with no steps in between, is just like swapping your BTC for ETH. As far as the IRS is concerned, you “sold” the first NFT for USD and then used USD to buy the second one. The sale triggers a capital gain or loss.

Fractionalized NFTs

A fractionalized NFT represents a piece of a larger work—kind of like a single piece of a puzzle. As an investor, you can generally treat a fractionalized NFT like any other NFT for tax purposes. In some cases, owning a fractionalized NFT may be considered ownership in a partnership.

Pawning or Loaning NFTs

Marketplaces have now sprung up where NFTs can either be loaned to others or used as collateral for loans. This allows NFT owners to enter the wide world of DeFi. Typically, taking a loan or loaning something out are not taxable events. Interest earned is taxable income at the fair market value of the interest received. Interest paid with cryptocurrency is a spend that can trigger a capital gain or loss. That being said, the tax implications depend on how exactly the NFT lending service is set up. See the “Decentralized Finance (DeFi) Taxes” section for more details about different lending scenarios.

NFTs and Airdrops

Sometimes, owners of specific NFTs are awarded airdrops of other tokens. For example, owners of Cool Cats NFTs receive MILK tokens. While the IRS has not issued guidance on NFT-specific airdrops, they have provided clarification on airdrops in general. It is very likely that tax rules of airdrops apply whether these tokens are fungible or non-fungible; see the “Ordinary Income” section for more details.


Decentralized Finance (DeFi) Taxes

Here are some common DeFi situations and their tax implications. Keep in mind, though, that these are also situations the IRS hasn’t released specific guidance for.

Borrowing

Loans are not considered taxable income; paying off a loan is not a deductible business expense. Still, your crypto activity should always be recorded so you can follow coins’ movements and keep track of your cost basis and acquisition date. Plus, paying interest with cryptocurrency is a spend that creates a capital gain or loss. If you have to convert crypto to pay back a loan, then that conversion will have a capital gain or loss.

Lending, Liquidity Pools, and Earning Interest

DeFi lending opens up some complex tax questions. The more aggressively you pursue degen status and move your tokens around to different DEXes, the more likely you are to have a tax headache. The tax treatment of DeFi lending depends on what’s actually going on under the hood.

Protocol Tokens or Placeholder Tokens

You want to earn interest on your ETH, so you deposit 3 ETH into Compound. You receive 3 cETH in exchange; these represent your interest in the liquidity pool. As your ETH swirls around in the liquidity pool, the cETH you’ve received becomes worth more ETH over time. When you’re ready to exit the pool, you return your 3 cETH and receive 5 ETH back.

What does this mean for taxes? While the IRS hasn’t released any specific guidance on this topic, our stance is that swapping ETH for cETH is likely a taxable event. Similarly, swapping your cETH back to ETH is a taxable event. Each event triggers a capital gain or loss. Some people out in the cryptosphere argue that these events are not taxable; you’re just placing your ETH somewhere and earning interest on it. We think this is extremely aggressive advice and that the IRS is very unlikely to support this stance in an audit.

⚠️ RSA Note—Idk about the above. Is lending your ETH on Celsius a taxable event? If no, I don’t see a difference between that and cETH. Maybe a good question for your tax advisor.

Earning Governance Tokens

On Compound, in addition to earning yield on the ETH you provided to the pool, you also earn COMP tokens as rewards. These are Compound’s governance tokens. These rewards are considered ordinary income.

No Coin Swaps—Just Sweet, Sweet Rewards

You want to earn interest on your ETH, so you deposit 3 ETH into Celsius. You don’t get any kind of placeholder token in return. You’re regularly awarded more ETH into your account—the interest you’ve earned by providing liquidity. In our view, putting ETH into Celsius is not a taxable event; neither is withdrawing it. The interest you earn is taxed as ordinary income.

Wrapping Coins

Sometimes, you need to wrap coins in order to interact with a specific DEX. For example, you might wrap BTC in order to use it on an Ethereum protocol. The wrapped BTC is called wBTC. This is a legal gray area, but we think there’s a strong argument that it is not a taxable token-to-token swap—assuming that nothing is being added to the wrapped token that would alter its use or value in any meaningful way. Each wrap should be reviewed case by case and the conservative approach would be to treat this as taxable.


Gas Fees

DeFi activity often involves a whole series of transactions. When you’re operating on an Ethereum network, that means you pay lots of gas fees. These fees are paid to node operators for maintaining the blockchain. You may be able to subtract or add gas fees from or to your capital gains or cost basis, depending on what they’re being used for.

Making Purchases

Gas fees can be added to your cost basis.

Selling or Disposing of Tokens

Gas fees can be subtracted from sales proceeds.

Trading Crypto for Crypto or NFT for NFT

When you trade one type of token for another, there’s technically a sale and a purchase happening at once. Remember, it’s as if you sold the first token for USD and then used USD to buy the second token. How do gas fees come into play here? You can subtract the fees from the first token’s sales proceeds or add them to the cost basis of the second token. The first option is typically easier from an accounting perspective.

Transferring Between Your Own Accounts

Even though you might have to pay gas fees for moving your crypto from one account to another, the conservative position is that these fees shouldn’t be part of your capital gain calculations.


Decentralized Autonomous Organization (DAO) Taxes

We can hardly have a Bankless tax guide without including the other pillar of decentralization: DAOs, which have been rising in popularity throughout 2021. Here are a few common tax scenarios you need to consider as an investor/collaborator/member in a DAO.

When DAO Tokens Increase in Value

Most DAOs raise funds through initial coin offerings (ICOs), aka token sales or crowdsales. Early investors can buy governance tokens which allow them to vote on projects. If your DAO tokens increase in value, that doesn’t inherently create a taxable event. If you sell, trade, or otherwise dispose of those tokens, you’ll have a capital gain or loss.

Receiving Dividends or Other Income in Crypto

DAOs will often award members income in the form of crypto tokens on a weekly or monthly schedule for their participation in the DAO. These rewards are taxed as ordinary income.

Form K-1

Some DAOs are structured to give investors partial ownership in a formally registered company. In this case, each partner will receive Form K-1 at the beginning of the year. Form K-1 reports each partner’s share of the company’s revenue, deductions, and credits.

This information should be reported on your individual tax return, but exactly where depends on the business setup and the type of income you receive. Consult a tax professional regarding your specific situation.

Receiving Airdrops

Many DAOs also airdrop various tokens to their users. Whether the airdropped tokens are fungible or non-fungible, these are taxed just like any other airdrops; see the “Ordinary Income” section for more details.

Starting a DAO

If you want to create your own DAO, there’s an enormous maze of tax and legal questions to sort through. As far as the IRS (and SEC, for that matter) is concerned, somebody has to own the business. We highly recommend speaking to an attorney who can help you navigate the legal gray areas before diving headfirst into a new DAO.


Reporting Cryptocurrency On Your Taxes using ZenLedger

There is one main form that is critical to crypto tax reporting: your Form 8949. All of your cryptocurrency trades, and sales, should be reported on this form. This is one of the most important steps for anyone filing their crypto taxes, and crypto tax software like ZenLedger can help make the process of filling this form out easier.

You should also be filling out your Schedule 1 for any crypto related income and your Schedule D form for your cryptocurrency taxes, as well. This is the standard form for reporting overall capital gains and losses.

Submit these forms, and your crypto tax headaches are over... at least, until next year!


Action steps

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.

Disclosure. From time-to-time I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Bankless writers hold crypto assets. See our investment disclosures here.

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