DeFi Taxes: A Guide for 2026

Decentralized finance has revolutionized banking, but the taxation legislation of it is becoming more and more centralized. 

Still, the IRS hasn’t yet provided clear instructions for DeFi investors, and even today you have to navigate a landscape of crypto rules and general tax principles that can be complex at times.

How DeFi Taxes Work

The main thing to be aware of is that the IRS looks at every interaction on the chain as either Capital Gains or Ordinary Income, which in turn determines what tax obligations you will have for that year.

Lending, Borrowing, and Liquidity Pools

In the DeFi lending space, the IRS has stricter oversight and has introduced the Form 1099-DA, so any interest earned when depositing crypto into a DeFi lending platform is often treated as a taxable swap if receipt tokens are issued.

Any interest you earn this way will be taxed as ordinary income, while liquidations are considered as capital gains or losses, so you’ll owe taxes on the difference between the collateral’s cost basis and its value at the time of liquidation.

Yield Farming and Governance Tokens

With yield farming, the rewards you harvest, which are primarily paid out in governance tokens, are considered by the IRS as ordinary income as soon as you gain control over them.

The taxes you owe are based on the fair market value on that day, and in the cases when the value of these tokens rises afterward and you decide to sell them, you will owe capital gains on that appreciation.

Decentralized Index Protocols and Automated Portfolios

With DeFi index protocols and automated portfolio managers, you have to be aware that every rebalancing of a protocol is a taxable event, even when it is executed automatically.

The IRS has recently doubled down on broker reporting for digital assets, but the majority of protocols are still struggling with issuing the forms, so the burden of reporting on high-frequency rebalances falls to you as an investor.

For example, each time that your automated index swaps currencies to maintain its weighting, you will have to calculate the capital gain or loss at the exact moment of the trade, the same that you would if you performed the swap manually.

Wrapping and Bridging Assets

This is another area that is still in the gray zone, we’d advise that you treat the wrapping of assets as a crypto-to-crypto swap, as you may trigger a capital gains event in cases when your asset appreciated in value since you bought it.

Bridging follows a similar logic. While a pure transfer between two of your own wallets on different chains isn't taxable, most bridges require you to swap your native token for a bridge-version of that token. 

Today, the IRS has a much clearer window into these cross-chain movements, so keeping meticulous records of your cost basis is no longer optional.

Tax-Loss Harvesting in DeFi

If you’ve suffered losses due to a specific digital asset crashing in the past year, you can definitely use tax-loss harvesting to sell the asset in order to realize a capital loss, which you can in turn use to offset capital gains from other trades.

If your losses exceed your gains, you can even use up to $3,000 of that loss to offset your regular salary income.

The Benefits of DeFi for Your Taxes

Decentralized finance offers quite a few advantages in this area, especially when compared to traditional stock-based portfolios, namely:

• Precision Tax-Loss Harvesting: Unlike traditional markets that close at 4:00 PM, DeFi is 24/7, allowing for much more flexibility if you want to harvest your losses.
• Strategic Planning: With DeFi, you have the total freedom to move or donate your assets and claim immediate deductions, without having to ask for a broker’s permission which usually comes with a fee in traditional trading.
• Record Keeping: Every single transaction is etched forever on the blockchain. There are also many tools today that allow you to follow and document this trail so it becomes practically impossible to lose.
• Customizable Lot Selection: In DeFi, you can choose exactly which lot of tokens you are selling. This allows you to minimize your capital gains by selling the tokens you bought at the highest price first.
• Expense Deductibility: If you are a professional trader or a business owner, you can use protocol fees and gas costs to lower your taxes as these are directly deductible as investment expenses.

The Drawbacks of DeFi for Your Taxes

The same features that make DeFi revolutionary also make it a primary target for IRS scrutiny.

• Taxable Event Multiplication: In DeFi, a single trade commonly takes a few steps to complete, from wrapping, to bridging, swapping and finally staking, and the issue is that each of the steps you take can be viewed as a separate taxable event.
• Ordinary Income vs. Capital Gains: Much of the profit in DeFi is taxed as ordinary income, which can be as high as 37%. This is a significantly more costly tax when compared to 15-20% you’d pay on capital gains in traditional stock investing.
• Complexity of Receipt Tokens: When you deposit into a pool and get a token back, the IRS views this as if you've sold your original asset. This forced gain can trigger a tax bill even if you never intended to sell.
• Increased Audit Risk via 1099-DA: The IRS is now using advanced chain-analysis tools. If your centralized exchange reports a transfer to a private wallet via Form 1099-DA, but you don't actually report the subsequent trades, you are essentially flagging yourself for an audit.

Final Words

The entire tax system in DeFi lies in the distinction between what is taxed as income, and what is taxed as a capital gain.

As you can see from the examples we’ve given, there are quite a few nuances and gray zones still persistent in this market, so it is best that you approach each of your trades with this in mind, and ensure that you have a full understanding of your tax obligations before making a move.