DeFi Taxes Explained: A Complete 2026 Guide

Decentralized finance (DeFi) has transformed how people earn, lend, borrow, and trade cryptocurrency. But with that innovation comes a tax reporting challenge that goes far beyond simple buy-and-sell transactions. Staking rewards, lending interest, liquidity pool deposits and withdrawals, yield farming, governance tokens, wrapped assets, and bridge transfers each create their own tax questions -- and the IRS has provided only limited guidance on many of these activities.

This guide covers how each major DeFi activity is taxed in the 2026 tax year, the IRS guidance that exists, the common mistakes people make, and the record-keeping practices you need to stay compliant.

The Fundamental Rule: Crypto Is Property

Before diving into DeFi-specific scenarios, it is essential to understand the foundation. The IRS classifies all cryptocurrency as property under IRS Notice 2014-21. This means that every disposition of crypto -- whether selling, trading, swapping, or using it in a DeFi protocol -- can trigger a taxable event. Additionally, any crypto received as income (rewards, interest, airdrops) is taxed as ordinary income at its fair market value on the date of receipt.

With DeFi, the challenge is that a single interaction with a protocol can involve multiple taxable events. Depositing tokens into a liquidity pool, receiving LP tokens, earning trading fees, claiming reward tokens, and then withdrawing and swapping back may each have separate tax implications.

Staking Rewards

How Staking Is Taxed

Staking rewards are treated as ordinary income by the IRS. When you receive staking rewards -- whether from proof-of-stake validation, delegated staking, or liquid staking protocols -- the fair market value of the tokens at the time you gain dominion and control over them is taxable income.

"Dominion and control" means the point at which you can freely sell, transfer, or use the tokens. For most staking arrangements, this is the moment the rewards are credited to your wallet or become claimable. The income is reported on your tax return regardless of whether you actually sell the tokens.

Example

You stake 32 ETH on the Ethereum network. Over the course of the year, you earn 1.6 ETH in staking rewards. Each time a reward is credited, you record the fair market value. If the average price of ETH when rewards were credited throughout the year was $3,200, your total staking income is 1.6 x $3,200 = $5,120 in ordinary income. This $5,120 is also your cost basis in those 1.6 ETH. If you later sell them for more than $3,200 per ETH, you will owe capital gains tax on the difference.

Liquid Staking (stETH, rETH, cbETH)

Liquid staking protocols like Lido (stETH), Rocket Pool (rETH), and Coinbase (cbETH) add a layer of complexity. When you deposit ETH and receive a liquid staking token in return, the tax treatment depends on whether the exchange is considered a taxable disposition:

• Rebasing tokens (stETH): With Lido's stETH, your token balance increases daily to reflect accrued rewards. Each rebase is generally treated as a receipt of income, taxable at the fair market value of the additional tokens received.
• Value-accruing tokens (rETH, cbETH): With Rocket Pool's rETH, the token does not rebase -- instead, each rETH becomes redeemable for an increasing amount of ETH over time. There is an argument that no income is recognized until you sell or redeem the rETH, at which point the profit is a capital gain. This interpretation is not definitively settled by the IRS.

Given the ambiguity, document the approach you take and be prepared to justify it.

Crypto Lending

How Lending Is Taxed

When you lend cryptocurrency through a DeFi protocol (such as Aave, Compound, or MakerDAO) and earn interest, the interest is treated as ordinary income. The amount of income is the fair market value of the interest payments at the time they are received or become available to you.

Depositing Into a Lending Protocol

Many lending protocols issue receipt tokens when you deposit (for example, aTokens on Aave or cTokens on Compound). Whether depositing your crypto and receiving a receipt token is itself a taxable event depends on the specific mechanics:

• aTokens (Aave): Your aToken balance increases over time as interest accrues. The initial deposit may or may not be a taxable swap depending on interpretation. The accrued balance increase is generally ordinary income.
• cTokens (Compound): You deposit ETH and receive cETH at a specific exchange rate. When you redeem, you receive more ETH than you deposited. The difference between what you deposited and what you withdraw is interest income.

Borrowing Is Not Taxable

Borrowing crypto against your collateral is generally not a taxable event. Taking out a loan (for example, borrowing DAI against ETH collateral on MakerDAO) does not trigger a capital gain because you have an obligation to repay the loan. However, if your collateral is liquidated because you fail to maintain the required collateralization ratio, that liquidation is a taxable disposition of the collateral.

Liquidity Pools

Depositing Into a Liquidity Pool

When you deposit tokens into an automated market maker (AMM) liquidity pool -- such as those on Uniswap, Curve, SushiSwap, or Balancer -- you typically provide two (or more) tokens and receive LP (liquidity provider) tokens in return. The prevailing tax interpretation is that this deposit constitutes a taxable disposition of the tokens you deposited. You are effectively swapping your tokens for LP tokens, triggering a capital gain or loss based on the difference between your cost basis and the fair market value at the time of deposit.

Earning Trading Fees

As a liquidity provider, you earn a share of the trading fees generated by the pool. These fees accrue to your LP position, increasing its value. There are two potential tax treatments:

• Income as accrued: The fees could be treated as ordinary income as they are earned, similar to interest.
• Recognized at withdrawal: The fees could be treated as part of the capital gain or loss when you withdraw from the pool and redeem your LP tokens.

The IRS has not provided definitive guidance on which treatment applies. Many tax professionals recommend treating the fees as part of the capital gain or loss at withdrawal, but some take the more conservative approach of reporting them as income. Whichever method you choose, apply it consistently.

Impermanent Loss

Impermanent loss occurs when the relative price of the tokens in your liquidity pool changes after you deposit. When you withdraw, you may receive a different ratio of tokens than what you deposited. From a tax perspective, impermanent loss is reflected in the capital gain or loss calculation when you withdraw from the pool. It is not a separately deductible loss -- it is part of the overall gain/loss computation on the disposition of your LP tokens.

Withdrawing From a Liquidity Pool

Redeeming your LP tokens for the underlying assets is another taxable event. Your gain or loss is the difference between the fair market value of the assets you receive and your cost basis in the LP tokens. This calculation captures both any price appreciation/depreciation of the underlying tokens and any impermanent loss.

Liquidity Pool Event	Tax Treatment	Tax Type
Deposit tokens, receive LP tokens	Taxable disposition of deposited tokens	Capital gain/loss
Earn trading fees	Income or deferred to withdrawal	Ordinary income or capital gain
Withdraw (redeem LP tokens)	Taxable disposition of LP tokens	Capital gain/loss
Claim reward tokens	Income at fair market value	Ordinary income

Yield Farming

How Yield Farming Is Taxed

Yield farming typically involves providing liquidity or staking LP tokens in exchange for reward tokens (often the protocol's governance token). The reward tokens are treated as ordinary income at their fair market value when you receive them or when they become claimable.

Yield farming often creates a cascade of taxable events:

1. Acquire the initial tokens (purchase, which establishes cost basis)
2. Deposit into a liquidity pool (taxable disposition, as discussed above)
3. Stake LP tokens in a farm (may or may not be taxable depending on the mechanism)
4. Claim farming rewards (ordinary income at fair market value)
5. Sell or reinvest reward tokens (capital gain or loss based on difference between sale price and the income value you reported)
6. Unstake LP tokens (possible taxable event)
7. Withdraw from liquidity pool (taxable disposition of LP tokens)

Each of these steps must be tracked individually with dates, amounts, and fair market values.

Auto-Compounding Vaults

Protocols like Yearn Finance and Beefy Finance automatically reinvest your yield farming rewards. Each auto-compounding event is potentially a taxable event: you are receiving income (the reward) and then disposing of it (by depositing it back). The practical challenge is that auto-compounding can happen dozens of times per day, creating a massive number of micro-transactions to track.

Governance Tokens and Airdrops

Governance Token Rewards

Many DeFi protocols distribute governance tokens to users who participate in the protocol (for example, UNI tokens distributed to Uniswap users, or COMP tokens distributed to Compound lenders and borrowers). These token distributions are treated as ordinary income at the fair market value when received. Your cost basis in the governance tokens is the income value you reported.

Airdrops

Airdrops -- unsolicited distributions of tokens to your wallet -- are taxable as ordinary income at the fair market value on the date you gain dominion and control over the tokens. This generally means the date the tokens appear in your wallet and you have the ability to sell or transfer them. If you receive an airdrop and choose not to claim it, you may not have a tax obligation until you actually claim the tokens.

Wrapped Tokens and Bridge Transfers

Wrapping Tokens (ETH to WETH)

Converting ETH to WETH (Wrapped ETH) is one of the most debated DeFi tax questions. There are two schools of thought:

• Not taxable: Wrapping ETH to WETH does not change the economic substance of the position. You still hold the same value in the same asset. Some tax professionals argue this is analogous to transferring between wallets, which is not taxable.
• Taxable: From a technical standpoint, you are depositing ETH into a smart contract and receiving a different token (WETH) in return. Under strict application of the property-for-property exchange rules, this could be a taxable swap.

The IRS has not issued specific guidance on wrapping. Most practitioners lean toward treating it as non-taxable, but conservative filers may choose to report it. Regardless of your position, record the transaction and your cost basis in the wrapped token.

Cross-Chain Bridge Transfers

Bridging tokens from one blockchain to another (for example, moving ETH from Ethereum to Arbitrum or Optimism) raises similar questions. If the bridge issues a different token (a bridged representation), the same arguments apply as with wrapped tokens. If the bridge transfers the native token directly, it is more analogous to a wallet transfer. Document the bridge transaction, the fees paid, and the tokens received.

Common DeFi Tax Mistakes

1. Not Reporting Staking and Farming Rewards as Income

This is the most common mistake. Many DeFi users treat rewards as "free money" and only think about taxes when they sell. But the IRS considers rewards as income at the time of receipt. Failing to report this income is underreporting, which can result in penalties and interest.

2. Ignoring LP Token Transactions

Depositing into and withdrawing from liquidity pools are likely taxable events. Many users only track the initial purchase and final sale of their tokens, completely missing the intermediate LP token transactions. This can result in incorrect cost basis calculations and misreported gains.

3. Not Tracking Cost Basis Through DeFi Interactions

Every time a token changes form -- from ETH to LP token, from LP token to farm receipt, from farm receipt back to tokens -- the cost basis must be tracked through each step. Losing track of cost basis through a chain of DeFi interactions is one of the most common sources of errors on crypto tax returns.

4. Forgetting About Liquidation Events

If you borrow against crypto collateral and get liquidated, the liquidation is a taxable disposition. The gain or loss is based on the difference between the liquidation proceeds (the debt repaid) and your cost basis in the collateral. Many borrowers focus on the financial loss and forget the tax implications.

5. Double-Counting or Under-Counting Income

With rebasing tokens, auto-compounding vaults, and multiple reward streams, it is easy to accidentally count income twice or miss it entirely. Using a consistent methodology and documenting every step is essential.

Record-Keeping for DeFi Taxes

DeFi tax compliance requires more detailed record-keeping than traditional crypto trading. Here is what you need to track:

For Every DeFi Transaction

• Transaction hash: The on-chain identifier for every interaction
• Date and time: The exact timestamp of the transaction (use UTC for consistency)
• Tokens sent: Type and quantity of tokens deposited or swapped
• Tokens received: Type and quantity of tokens received (LP tokens, reward tokens, etc.)
• Fair market value: The USD value of all tokens at the time of the transaction
• Gas fees paid: These may be added to your cost basis or treated as a deductible expense
• Protocol and chain: Which DeFi protocol and blockchain the transaction occurred on

Tools and Best Practices

• Export wallet transaction history from block explorers like Etherscan, Arbiscan, or Solscan
• Use portfolio trackers that support DeFi protocols to automatically categorize transactions
• Maintain a spreadsheet that maps each DeFi interaction to its tax treatment (income, capital gain, non-taxable transfer)
• Screenshot token prices at the time of significant transactions as backup evidence
• Document your tax methodology for ambiguous situations (wrapping, LP fee treatment, auto-compounding). If you are consistent and can justify your approach, you are in a much stronger position in case of an audit.

What IRS Guidance Exists for DeFi?

As of early 2026, the IRS has provided limited guidance specifically addressing DeFi. The primary sources of authority are:

• IRS Notice 2014-21: Established that cryptocurrency is property. This is the foundational guidance that applies to all crypto transactions, including DeFi.
• Revenue Ruling 2019-24: Addressed airdrops and hard forks, establishing that tokens received from these events are ordinary income.
• Revenue Ruling 2023-14: Confirmed that staking rewards are taxable as income when received by cash-method taxpayers.
• Infrastructure Investment and Jobs Act (2021): Extended broker reporting requirements and wash sale rules to digital assets, effective for tax years 2025 and beyond.

Notably absent is specific guidance on liquidity pool taxation, wrapped token treatment, yield farming reward categorization, and the tax treatment of DeFi-specific mechanisms like flash loans, concentrated liquidity positions, and cross-chain bridges. In the absence of specific guidance, tax professionals apply the existing property framework by analogy.

Should You Hire a DeFi Tax Specialist?

If you have significant DeFi activity -- multiple protocols, liquidity pools, farming positions, and cross-chain interactions -- the complexity of accurate tax reporting is substantial. A tax professional with specific DeFi experience can help you:

• Properly categorize each type of DeFi transaction
• Track cost basis through complex chains of interactions
• Choose and consistently apply a tax methodology for ambiguous situations
• Identify tax optimization opportunities you might miss
• Ensure compliance with the new Form 1099-DA reporting requirements

The cost of professional help is often far less than the penalties for incorrect reporting or the tax savings from proper optimization.

Final Thoughts

DeFi taxes are arguably the most complex area of cryptocurrency taxation. The combination of limited IRS guidance, rapidly evolving protocols, and multi-step transactions creates a reporting challenge that is unlike anything in traditional finance. But the fundamental principles are straightforward: crypto received as rewards or interest is ordinary income, and dispositions of crypto trigger capital gains or losses.

The key to DeFi tax compliance is meticulous record-keeping. Track every transaction, record fair market values at the time of each event, document your methodology for ambiguous situations, and maintain those records for at least six years. If your DeFi activity is complex, work with a tax professional who understands the space.

This guide is for informational purposes only and does not constitute tax, legal, or financial advice. DeFi tax law is evolving rapidly. Consult a qualified tax professional for advice specific to your situation.