How do I report DeFi income on my US tax return?

Decentralized Finance (DeFi) activities create various tax obligations that must be reported on your US tax return. While the IRS has not issued comprehensive DeFi-specific guidance, existing tax principles for property transactions and income apply. Here is how common DeFi activities are typically reported.

Liquidity Provision: When you provide liquidity to a decentralized exchange (like Uniswap or SushiSwap), you receive LP tokens in return. Adding liquidity may or may not be a taxable event depending on the specific protocol and how the transaction is structured. Removing liquidity and receiving back different amounts of tokens than you deposited generally triggers a taxable event. Trading fees earned through liquidity provision are taxable income.

Yield Farming: Rewards earned from yield farming protocols are generally taxable as ordinary income when received, similar to staking rewards. This includes governance tokens earned as incentives, interest paid by lending protocols, and reward tokens from farming pools. Report this income at fair market value when received.

Lending and Borrowing: Interest earned from lending crypto on platforms like Aave or Compound is taxable ordinary income. Borrowing against crypto collateral is generally not a taxable event (similar to taking a margin loan). However, if your collateral is liquidated, that is a taxable disposal of the collateral.

Token Swaps: Every swap of one token for another on a DEX is a taxable event — you must calculate the capital gain or loss based on your cost basis in the token you give up and the fair market value of the token you receive. This includes swapping through aggregators like 1inch or Paraswap.

Wrapping and Unwrapping: Wrapping ETH to WETH or wrapping tokens for cross-chain bridges may or may not be taxable events. The IRS has not issued clear guidance, but many tax professionals treat same-chain wrapping as non-taxable and cross-chain bridges as potentially taxable.

Report capital gains and losses on Form 8949 and Schedule D. Report ordinary income (farming rewards, lending interest, etc.) on Schedule 1 as Other Income. Use crypto tax software that supports DeFi transaction tracking — manual tracking of DeFi activity across multiple chains is extremely challenging.