DeFi Taxes for Yearn Finance Users: A Comprehensive Guide

Many protocols in the DeFi and crypto space are seeking innovative ways to take full advantage of the expanding DeFi ecosystem. Yearn Finance has responded to the challenge of providing innovative, decentralized finance solutions, allowing users to generate revenue on digital assets following sophisticated strategies.

In this comprehensive tax guide, we help you understand how to navigate the complex tax landscape of Yearn Finance products. We break down the taxable events triggered when interacting with the protocol and discuss the IRS guidance on crypto asset taxation.

What is Yearn Finance?

Yearn is a decentralized platform that serves as an automated aggregator helping DeFi investors maximize their yield farming income. It achieves that by simplifying the complex strategies for those who are not tech-savvy or prefer a more automated investment strategy. 

The platform uses a set of automated smart contracts to help users optimize their investments in different DeFi protocols, such as Aave, Compound, and Curve. The YFI token is the native governance token of Yearn Finance. Besides governance, it can also be used for other purposes such as staking. Yearn offers several products including yVaults, yCRV, yBribe, and WOOFY. These allow users to earn a yield on their deposited assets through various strategies.

What Are Yearn Finance Taxes?

As a cryptocurrency investor using Yearn Finance, it’s important to understand that your transactions may be subject to capital gains or income tax. This means that you may need to report your transactions on your tax return and pay taxes on any gains or income you earn using the protocol

Capital gains tax is applied on the profits earned from selling an asset like cryptocurrency. Short-term capital gains apply to assets sold within a year and are taxed at the individual’s ordinary income tax rate. Long-term gains apply to assets held for over a year and are taxed at a lower rate. 

Income taxes, on the other hand, are imposed on an individual’s income, including cryptocurrency earnings from yield-generating activities, staking, or receiving payments. Any income from cryptocurrency transactions is subject to tax.

Taxable Events For Yearn Finance Users

Below, we break down the taxable events that can occur while using the YFI protocol. These include trading one asset for another, selling cryptocurrency, staking, earning income from yield-generating activities, and other DeFi strategies.

Trading One Asset For Another

When you exchange one crypto for another it’s considered a disposal of an asset for tax purposes. For instance, if you swap ETH for YFI and its value goes up since you got it, you may need to report a capital gain. Conversely, if the value of YFI has gone down, you may be able to report a capital loss.

Selling Rewards for Crypto

If you decide to sell any rewards perceived from vaults or strategies of the Yearn Finance platform you are incurring into a crypto-to-crypto trade, which is a taxable event and falls under the scope of Capital Gains taxation. 

Staking your crypto

Staking is the process of temporarily committing crypto assets to a smart contract in order to function as a validator while earning tokens as compensation. The IRS has not provided detailed instructions on staking taxation. However, by taking a conservative approach and categorizing it as similar to mining income we might say that staking income is liable to income tax based on its fair market value at the time of receipt. In this case, staking your yCRV tokens will be subject to taxation. In summary, staking rewards should be regarded as income when received and as capital assets when sold in order to comply with tax requirements, being subject to both income tax and capital gains tax. 

Wrapping Tokens

Although the IRS has not issued guidance on how to tax wrapped tokens, a conservative approach would dictate that these transactions are subject to taxation. Even though the wrapped assets hold the same value, the smart contract is different and therefore it represents a crypto-to-crypto trade. It’s critical to comprehend how wrapping affects your taxes if you own wrapped tokens. To learn more about the tax ramifications of wrapped tokens and their unique tax treatment, please consult a tax expert and analyze each situation separately to determine the specific tax implications.

Earning tokens from Yearn Finance Strategies 

Vaults and Strategies operate in a very similar way, when you make a deposit, your money goes to the vault contract and is later sent to different strategy contracts. Then, they collect your deposit and then route it through strategies that look for the maximum payout in DeFi. Any reward token perceived from yield farming activities will be subject to income tax at the fair market value (FMV) when tokens are received. 

Vault tokens 

The yVault Tokens serve as a receipt for your deposit and reflect how much ownership you have in the yVault. If you store YFI in a yVault, you will receive yvYFI Tokens. In case the yVault generates profits, the value of your Tokens rises since there are more assets in the yVault. This occurs because there are additional tokens held in the yVault that can be retrieved when you withdraw your investment. These tokens are ERC20, which means they can be exchanged and transferred in the same way as other Ethereum tokens may.

Although the IRS hasn’t issued any guidance regarding taxation on these scenarios involving complex DeFi transactions on the Yearn Finance protocol, we can make an educated guess. Taking a conservative approach, the act of receiving yvYFI will be a taxable event and subject to capital gains, since you are receiving a new token. On the other hand, rewards will be taxed as income when received and in case they are swapped to another asset the transaction will be subject to capital gains since you are disposing of an asset for another one. 

Vault Factory

The IRS has not provided any official instructions on how to tax the Vault Factory product or similar strategies in DeFi, but despite this absence of guidance, by taking a conservative approach we can still make informed assumptions about the taxation. 

The Vault Factory offers multiple yield strategies, this includes staking CRV, being a liquidity provider of CRV, and many more. Taxation on these will depend primarily on the transactions executed. Moreover, in summary, any income derived from these activities will be taxed as income when received at the FMV when received and any trades involving crypto-to-crypto transactions will be subject to capital gains. 

Non-Taxable Events

It’s important to note that not all transactions on the Yearn Finance platform are taxable events. For example, transaction fees and other costs associated with using the platform like smart contract approvals are generally not taxable events.

Additionally, holding crypto in a wallet is not considered a taxable event. However, if you hold crypto as an investment and later sell it for a gain or loss, this would be considered a taxable event.

Transaction Fees and Other Costs

When you use the Yearn Finance platform, you may incur transaction fees or other costs associated with using the platform. These fees are generally not considered taxable events and do not need to be reported on your tax return.

However, it’s important to keep track of these fees as they can affect your cost basis when calculating capital gains or losses. For example, if you pay a transaction fee when swapping ETH for YFI on the Yearn Finance platform, this fee would increase your cost basis in YFI and therefore will affect your capital gains.

Holding Crypto In a Wallet

Holding crypto in a wallet is not considered a taxable event. This means that simply holding crypto in a wallet does not trigger any tax obligations.

However, if you decide to sell it later for a gain or loss, this would be considered a taxable event. In this case, you would need to report any capital gains or losses. It’s also important to note that holding crypto for more than one year can qualify you for long-term capital gains treatment. This means that any gains would be taxed at a lower rate than short-term capital gains.

IRS guidance on Yearn Finance taxes

There is no specific guidance issued by the IRS on Yearn Finance taxes. However, as mentioned earlier, the IRS treats digital assets as property for federal tax purposes. This means that any gains or losses from disposing of cryptocurrency are subject to capital gains tax rules. Additionally, income earned from mining or staking cryptocurrency is subject to income tax rules.  You may be required to report your digital asset activity on your tax return using Form 8949 to report the sale, exchange, or disposition of cryptocurrency. It’s always a good idea to consult with a tax professional for specific guidance on your individual tax situation.

Use A Crypto Tax Software For Your Yearn Finance Taxes

Using a crypto tax calculator can help simplify the process of reporting your Yearn Finance transactions. You only need to connect all your wallets and the system will import all of your transactions automatically and calculate the cost basis and capital gains/losses of each trade on your crypto assets, so that you can easily see how much tax you owe. Additionally, the platform offers additional tools like Tax Loss Harvesting to help optimize your taxes and minimize your tax liability based on your worst-performing trades. 

How Can Accointing Help With Yearn Finance Taxes?

Accointing can help with Yearn Finance taxes by providing an easy-to-use tool that simplifies the process of reporting your crypto transactions. With the easy integration with multiple centralized exchanges, DEXs, and wallets, users will be able to file a tax report in a few simple steps that involve identifying unknown currencies. Internal transactions, missing funds, and solving unclassified transactions issues. 

With the review tool, you can quickly categorize all of your transactions for taxes, regardless of whether you engage in DeFi staking, farming, or swaps. Also, by using the holding period tool you can determine ways to possibly save on taxes, by optimizing your taxable gains and identifying which tokens you have kept for more than a year and which ones you have held for less than a year. 

Main Takeaways

• Understanding DeFi taxes for Yearn Finance users is essential for staying compliant with IRS guidance.
• By using a crypto tax calculator and remaining aware of taxable events while interacting with DeFi protocols, you can easily report your transactions accurately while optimizing your taxes.

Don’t let taxes hold you back from taking advantage of all that DeFi has to offer! Sign up for Accointing today and take control of your crypto investments.

The information contained in this guide, including any supplemental materials, is for general information purposes and does not constitute financial, investment, legal or tax advice. The present content is not intended as a thorough, in-depth analysis, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. Please consult your tax advisor.