Background
We have published an in-depth guide for DeFi taxes which includes specific examples for a wide range of products including lending and borrowing which you can check out. If you want a brief overview of how lending crypto will impact your tax obligation keep reading.
With the DeFi boom in crypto one of the main ideas behind breaking the banking industry has been around the borrowing and lending space, why go through a bank when you can lend your money at a higher interest rate on a decentralized platform, while maintaining control over your funds, security, and privacy.
The basic idea is the same as how lending money works in the broader financial system. You lend your capital and in return receive interest and your initial capital stake. In the DeFi world, one of the interesting tax differences is around how your interest is paid out.
Income Tax
In this case, you deposit funds, and the interest is airdropped to your account periodically. Just like if you deposited funds at a bank the interest you earn is subject to income tax. The income tax is based on the value of the currency you receive in the airdrop at the time of the airdrop. If you decide to hold the currency longer and sell later you will be subject to capital gains when you sell.
Capital Gains
Some DeFi platforms use their own tokens to accrue interest. You deposit your funds and in return, they are transferred into the platforms native token (cTokens for example). You earn interest just like you would in the income tax approach however the interest isn’t airdropped to your account, instead, the value of the platform’s tokens increase and you only pay a capital gains tax when you decide to withdraw your funds and transfer the platform tokens back to ETH or a stable coin.
This approach has the benefit of avoiding income tax and you can decide when you take the tax hit.
Important points to remember when lending crypto
No matter what platform you use there are a few key points it’s worth remembering:
- If the platform you use automatically transfers your tokens to the platforms native tokens or wraps it this is a capital gain event as you are transferring one currency for another.
- If you are airdropped any tokens this is considered income and is subject to income tax
- If the value of the platform coins you hold increases when you withdraw them it is a capital gains event as the value has changed, it could be a capital loss if the tokens value in AUD terms decreases.
Wrapping Up
DeFi lending can be a complicated space and with the industry evolving so rapidly many tax regulators haven’t had time to keep up. These rules are based on interpretations that were created for the general crypto space. It is important to know that the ATO could update these regulations but it is good to know the base regulations in the meantime.
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