Crypto Loan Tax: Your Comprehensive Guide
Understand what crypto loans are and how their taxes work.
Crypto loan taxes are a useful tool for most crypto investors. Although getting one isn’t really a taxable event, there are some cases where you must pay taxes. However, the IRS has yet to release more specific crypto loan tax guidelines.
Cryptocurrencies are a new asset class in the finance world, meaning the IRS still doesn’t have a customized way of taxing their transactions. This has left many people wondering whether or not to pay crypto loan taxes and how to go about it. Fortunately, the IRS has some general guidelines that can help determine whether you owe any taxes. This post will help you understand what crypto loans are and how their taxes work.
What Are Crypto Loans?
Unlike a fiat loan, this loan uses cryptocurrency as collateral and must be overcollateralized. For instance, if you want a $2000 loan, you require about $4000 in crypto collateral. This is mostly because the collateral assets are usually volatile. Therefore, over-collateralization enables the loan to maintain its loan-to-value (LTV) ratio when the market gets volatile and doesn't require a credit score or credit check.
Investors love crypto loans because they allow you to access the funds you need without selling your crypto holdings. Therefore, if you plan on holding bitcoin for 10 years or more, you don’t need to sell them when you need money during this period. You can just use the assets as collateral to get a loan, fund your projects, and then repay the debt while your assets remain in the market.
You can get a crypto loan from any trusted crypto platform. The best ones today include Nexo and BlockFi. Check out this guide if you want more details on the safest loan platforms.
Are Crypto Loans Taxable?
Crypto loans are taxable. But there are also some non-taxable events you should know about. First, you should note that receiving a crypto loan is not a taxable event. The same applies to how you spend the loan, especially if you borrowed in fiat or stablecoins since your assets don’t incur capital gains taxes. Also, if your collateral assets gain some value during the loan period, you are not liable to pay crypto tax.
Interest payments are usually tax-deductible. So, you can exclude them when recording your taxes. However, this only applies to cryptocurrency loans taken for investment purposes, such as rental property. If you borrow digital assets to invest in yield farming or similar protocols, then the investment interest expense is also tax-deductible. However, this is not the case for a personal loan. If you take a loan to cover personal expenses such as tuition or shopping, the interest payments are not tax-deductible.
You should note that the profits you make from your investments with the crypto-backed loan might be taxed as personal income or capital gains. This depends on the nature of your transaction.
Are Crypto Loan Liquidations Taxed?
A loan platform usually returns collateralized assets once you clear your debt. If the loan’s value reduces beyond the agreed loan-to-value ratio, the lender might ask for additional collateral. If you fail to do so or default on the loan, the lender liquidates your crypto assets. This creates a realized capital loss or gain, making it a taxable event. Note that you will be forced to pay capital gains taxes even if you don’t receive any money from the liquidation.
Are Self-Repaying Crypto Loans Taxed?
Self-repaying loans are a new product in the crypto borrowing space. They are loans where you borrow money against the future yield of your invested assets. So, you submit your crypto collateral, and then the crypto platform deposits it in a yield generation protocol.
The lender uses your passive income from the yield farms to automatically settle the loan. So, instead of the debt appreciating over time, it reduces. This also minimizes the chances of your collateral being liquidated as you will likely remain in the required loan-to-value ratio for most of the loan period.
The IRS will likely consider your earnings from yield farming protocols as debt cancellation income, hence taxing you.
How to Report Crypto Loan Taxes
The easiest way to record and report crypto loan taxes is via crypto tax software. Browsing through different crypto exchanges to determine your taxable events can be quite draining. Fortunately, this software can help prevent that.
Most crypto tax software, such as CoinLedger and Koinly imports your crypto transactions from different exchanges and puts them in one place. This makes it easier to analyze everything. They calculate your taxes and then compile them into a report that you can easily download and use to report your crypto taxes. Plus, crypto tax software integrates with many crypto exchanges, enabling you to easily import all your transactions.
Most crypto investors only report their crypto lending taxes but forget to include their crypto loan proceeds. If that’s you, we hope this article has helped you understand how crypto loan taxes work and how to report them easily.