Do you have to pay taxes on yield farming?
Billions of dollars have been locked (allocated) into DeFi protocols, where investors receive interest or tokens as a return from their investment. How are the crypto yield farming rewards taxed in the US? Let’s find out.
In this article:
How does crypto yield farming work?
Yield farming consists of locking funds (allocating funds) in a DeFi protocol, where you’ll receive a return in the form of interest, fees, or new tokens.
Popular decentralized exchanges like Uniswap or SushiSwap have locked billions of dollars while offering attractive annual percentage yields (APYs) to allure investors.
Investors can receive interest in the forms of stablecoins, a percentage of the transaction fees, or new tokens from the protocol they locked funds into. Let’s find out how yield farming taxes work in the US.
Do you pay taxes on yield farming?
Yes, yield farming is taxable in the US.
When you receive interest or a percentage of the transaction fees when locking funds into a protocol, you’re essentially receiving income, similar to receiving interest from providing a regular loan, which is taxable.
Yield farming and crypto staking have the same tax basis since you’re receiving interest/rewards from investing your crypto, which are taxable events in the US.
You need to assess the Fair Market Value (FMV) in USD of each interest/fee that you receive, which will add to your total income for the year. The amount of interest you receive will likely increase your total taxable income for the year, where you’ll have to pay income taxes according to your income level.
Do you pay taxes on crypto interest?
Any crypto interest must be recognized as income when it is received. You must assess the Fair Market Value (in USD) of the interest you received, and this amount will add to your total income for the year. This is similar to gaining interest from yield farming or crypto staking rewards.
Check our guide on how crypto interest is taxed for more information.
How is liquidity mining taxed?
Liquidity mining means receiving new tokens from locking funds into a liquidity pool. You’ll receive new tokens based on the proportion that you locked funds into the pool. These will likely be the native token of the protocol you are using. Liquidity mining is a subset of yield farming, which can become very lucrative given the rapid appreciation in the value of new DeFi tokens.
How are new tokens from liquidity mining taxed?
You have to determine the Fair Market Value of the tokens in USD when you receive them.
This will add to your total income for the year. The tax implication is the same as when you receive interest from common yield farming. The recognized income will become your cost basis in those tokens.
Do you have to pay taxes when selling liquidity mined tokens?
If you later sell the tokens that you received from liquidity mining, you’ll have to pay capital gains taxes if you had a profit. In either case, if you sell the tokens for crypto or FIAT at a gain/loss, you’ll have to report that trade on your taxes.
Let’s imagine that you received 100 units of token X, valued at $1 each. At the time you received the new token X, you reported its Fair Market Value ($100). A year later, each token is worth $10, and you decide to sell.
Your total sales proceeds will be $1000, and your cost basis is the Fair Market Value (in USD) of the tokens ($100) at the time when you first receive the tokens. The capital gains will be the difference between the sales proceeds and cost basis ($900). If you held the tokens for more than 12 months, you would be subject to a long-term capital gains tax rate, ranging from 0% to 20%, depending on your situation (e.g., filing status).
Holding crypto in the long-term (for more than 12 months) offers reduced tax rates in several countries.
Can you deduct fees from locking funds in yield farms?
Fees paid for locking your funds are usually considered an investment expense, and under the current US tax law, they are not deductible for individual investors. If you are a professional trader or running an investment business, you may be able to deduct the fees as business expenses.
Decentralized exchanges taxes
In the US, trading crypto on decentralized exchanges is a taxable event. If you trade crypto to crypto on DEXes like Uniswap, SushiSwap, or PancakeSwap, you’ll have to report those trades and determine the gain/loss on each trade. You’ll likely pay capital gains taxes on those trades if you have a profit.
Beyond trades, you can earn interest from providing liquidity to pools or even receiving airdrops from new protocols. In those cases, you need to determine the Fair Market Value (in USD) of the interest/tokens you received. You’ll need to recognize this as ordinary income and report it on your income tax return.
How is Uniswap taxed?
Trading crypto on Uniswap is a taxable event in the US. If you swap crypto on Uniswap, you’re trading crypto for another crypto, a taxable event in the US, subject to capital gains taxes.
If you provide liquidity to Uniswap and receive interest in return, you’ll have to determine its Fair Market Value (in USD) and recognize it as ordinary income.
For more details, check this guide on how to do your Uniswap taxes.
Do you have to report new tokens from yield farming income on taxes?
Yes. The tokens you receive must be reported as ordinary income in your yearly tax returns. You'll pay income tax on that, according to your total taxable income level in the US.
If you later sell new tokens you received from liquidity mining, you have to determine the gain/loss on each trade and report them on Form 8949 and Schedule D of your Form 1040.
How to do your yield farming taxes?
Here’s how to do your yield farming taxes in 3 steps:
Import your trades from DeFi protocols and decentralized exchanges to a crypto tax software such as CoinTracking.
Determine the Fair Market value of the interest you received in USD.
Report that income on your income tax return.
Learn how to import your DEX trades into CoinTracking for taxes:
The best DeFi tax software: CoinTracking
CoinTracking is the best DeFi tax software in the market, enabling you to easily import your DEX trades like SushiSwap and have your gains automatically calculated while generating all the necessary tax reports.
If you’re using an Ethereum-based DEX, you can easily import your trades in a few minutes with our ETH+DEX importer. After importing your trades, you can select one of the 12 accounting methods that CoinTracking supports, and we will calculate your gains for each trade while generating the tax reports.
Yield farming taxes with no errors: CoinTracking Full Service in the US.
CoinTracking also offers a Full Service for US traders. A crypto reconciliation tax expert from Polygon Advisory Group, a leading US crypto tax firm, will review your CoinTracking account, help fix any errors, and ensure you submit your crypto tax reports error-free.
Do you have any crypto tax questions? Check the best guides:
DeFi Taxes: The Complete Guide.
How to save taxes with a Bitcoin IRA.
Do you pay taxes for receiving Bitcoin tips?
Uniswap Taxes Guide
How to calculate taxes with Bitcoin dollar-cost averaging?
FIFO for crypto taxes? Implications of accounting methods.
NFT Taxes: The Complete Guide.
2021’s NFT guide (with taxes).
Is Bitcoin taxable? The ultimate guide for 2021 taxes.
Do you pay taxes on Bitcoin debit cards purchases?
Is Bitcoin taxable? The ultimate guide for 2021 taxes.
How to reduce your crypto taxes?
Crypto tax loss harvesting: Here’s what you need to know
This post is part of the Crypto Taxes AMA series. Follow our weekly AMAs on Twitter where our expert CPA, Sharon Yip answers your crypto tax questions. You can download 30+ AMA crypto tax reports for free.
Disclaimer: All the information provided above is for informational purposes only and should not be considered as professional investment, legal, or tax advice. You should conduct your own research or consult with a professional financial advisor when investing.