Cryptocurrency borrowing and lending are getting popular these days. The main reason is the rise of stablecoins and DeFi platforms. Although lending and borrowing dollars do not consider for taxation, borrowing and lending cryptocurrencies such as Bitcoin and Ether could result in taxation. The reason is that Bitcoin consider as property in U.S by the IRS. In this article we are going to talk about cryptocurrency loans taxation.
Cryptocurrency loans taxation; technical point of view
From technical perspective, the most important point in crypto loans is that they consider as property. Unlike U.S. dollar, most properties are not fungible.
Cryptocurrencies have core differences. In addition, in crypto lending, the borrower does not get back the same exact amount they deposited at the beginning. These two features could transform generally tax neutral loan transactions into taxable sale transactions in the crypto world.
Meanwhile, lending a property and receiving something else other than the original property at loan settlement could be considered as sale of the original property.
IRS still did not issue any regulations and guidance related to crypto loans
From all those above, in DeFi, when you borrow or lend cryptocurrency, the parties, who are involved in the transaction, wish to use a fungible asset same as U.S. dollar. But, still it remains a question that IRS will be agree with this treatment or not. In fact, the IRS still did not issue any regulations or guidance on how cryptocurrency loans should be taxed.
There are few best practices you can do to make in order to skip taxation. In fact, these practices exist due to lack of transparency in regulation by IRS. First of all, make sure that the documents related to both parties are treating the transaction as a loan, and not sale. Additionally, the documents related to the loan should have the requirement to return the collateral in the exact same cryptocurrency, which borrowed from the lender. In this case, the starter can preserve fungibility standards and prevent taxation for a sale.