LegalMoneyTalk: Uniswap Tax

DeFi has opened up incredible opportunities for crypto investors to earn passive income through liquidity pools and yield farming. But here is what most participants do not realize: the IRS treats almost every DeFi transaction as a taxable event. Adding liquidity, removing liquidity, claiming rewards, swapping LP tokens — each action can trigger tax obligations that catch users off guard.

I have been navigating DeFi taxes since the early days of Uniswap and Compound. What I have learned is that the complexity comes not from high tax rates, but from the sheer number of taxable events happening behind the scenes. A single yield farming strategy can generate dozens of taxable transactions per month. This guide breaks down exactly how DeFi is taxed in 2026 and what you need to track to stay compliant.

🌾 DeFi Tax Basics — Why It Gets Complicated

DeFi taxation is complicated because every on-chain action can potentially be a taxable event. Unlike holding Bitcoin in a wallet, DeFi protocols constantly move, swap, and transform your assets. The IRS has not released specific guidance for DeFi, so we apply existing crypto tax principles to these new activities.

The core principle remains the same: any time you dispose of cryptocurrency, you have a taxable event. Disposal includes selling, trading, swapping, or exchanging crypto for other crypto or goods. In DeFi, this happens far more frequently than most users realize. Depositing tokens into a liquidity pool often counts as a disposal because you are exchanging your tokens for LP tokens.

Rewards earned through DeFi protocols are generally treated as ordinary income. This includes yield farming rewards, liquidity mining incentives, and governance token distributions. The fair market value at the moment you receive control of the tokens becomes taxable income, just like staking rewards or mining income.

What I think makes DeFi taxes particularly challenging is the lack of centralized reporting. Traditional exchanges send 1099 forms to the IRS. DeFi protocols do not. You are entirely responsible for tracking every transaction, calculating fair market values, and reporting accurately. One mistake in a complex farming strategy can cascade into multiple errors on your tax return.

🌾 DeFi Taxable Events Overview

Action	Taxable?	Tax Type
Add Liquidity	Often Yes	Capital Gains
Remove Liquidity	Yes	Capital Gains
Claim Rewards	Yes	Ordinary Income
Swap Tokens	Yes	Capital Gains
Stake LP Tokens	Depends	Varies

📊 Need help tracking DeFi transactions?

Compare the top crypto tax software that supports DeFi protocols.

🔍 Best Crypto Tax Software 2026

💧 Liquidity Pool Taxes — Adding and Removing Liquidity

Liquidity pools are the backbone of decentralized exchanges like Uniswap, SushiSwap, and Curve. When you add liquidity, you deposit two tokens (like ETH and USDC) and receive LP tokens in return. This seemingly simple action can trigger multiple tax events depending on how the protocol handles your deposit.

The conservative view, which most tax professionals recommend, treats adding liquidity as a taxable disposal. You are exchanging your original tokens for LP tokens, which represents a new asset. If your deposited ETH has appreciated since you bought it, you realize that gain when you add it to the pool, even though you never sold for cash.

For example, you bought 10 ETH at $1,500 each for a total cost basis of $15,000. ETH rises to $3,000. You add 10 ETH plus $30,000 USDC to a liquidity pool. Under the conservative approach, you have disposed of ETH worth $30,000 with a cost basis of $15,000, triggering a $15,000 capital gain — even though you just moved tokens into a pool.

Removing liquidity works similarly but in reverse. When you withdraw from the pool, you exchange your LP tokens back for the underlying assets. The difference between your LP token cost basis and the value received determines your gain or loss. This gets complicated because the token ratio often changes due to price movements and trading activity in the pool.

💧 Liquidity Pool Tax Calculation Example

Step	Action	Tax Impact
1	Buy 10 ETH at $1,500	Cost basis: $15,000
2	ETH rises to $3,000	Unrealized gain: $15,000
3	Add to LP (10 ETH + $30K USDC)	Realized gain: $15,000
4	Receive LP tokens	New cost basis: $60,000

📋 Understanding crypto disposals?

Learn how the IRS treats crypto-to-crypto swaps and exchanges.

🔍 IRS Virtual Currency FAQ

🚜 Yield Farming Taxes — Rewards and Compounding

Yield farming takes liquidity provision a step further by adding reward tokens on top of trading fees. Protocols like Compound, Aave, and Yearn distribute governance tokens to incentivize participation. These rewards create ordinary income tax obligations the moment you receive them or gain control over them.

The tax treatment is straightforward in principle: farming rewards are taxed as ordinary income at the fair market value when received. If you earn 100 COMP tokens when COMP is trading at $50, you have $5,000 of ordinary income. This is taxed at your marginal rate, which can be as high as 37% for federal taxes plus state taxes on top.

Auto-compounding vaults complicate things significantly. When a protocol automatically harvests rewards and reinvests them, each harvest is a taxable event even though you never clicked a button. Some yield aggregators compound multiple times per day, potentially creating hundreds of taxable events per month. Tracking this manually is nearly impossible without specialized software.

The cost basis of your reward tokens equals their fair market value at receipt. When you eventually sell or swap those tokens, you calculate capital gains based on the difference between sale price and your income recognition cost basis. This means the same tokens get taxed twice: first as income when received, then as capital gains when sold if they appreciated.

🚜 Yield Farming Tax Timeline

Event	Tax Type	Rate
Receive 100 COMP at $50	Ordinary Income	Up to 37%
COMP rises to $80	No tax yet	—
Sell 100 COMP at $80	Capital Gains	0-20%
Total taxable: $5,000 income + $3,000 gain	Combined	Varies

💰 Staking rewards work similarly

Learn how staking income is taxed and when to report it.

🔍 Crypto Staking Taxes 2026

📉 Impermanent Loss — Can You Deduct It?

Impermanent loss is one of the most misunderstood concepts in DeFi, and its tax treatment is equally confusing. Impermanent loss occurs when the price ratio of tokens in a liquidity pool changes from when you deposited. You end up with a different mix of tokens than you started with, often worth less than if you had simply held.

Here is the frustrating reality: impermanent loss is not directly deductible as a loss on your tax return. The IRS does not recognize unrealized changes in asset composition as a taxable event. Impermanent loss only crystallizes into an actual tax loss when you remove liquidity and realize the difference between what you deposited and what you withdrew.

When you remove liquidity, you compare the fair market value of tokens received against your cost basis in the LP tokens. If the value received is less than your basis, you have a capital loss. This loss can offset capital gains from other crypto transactions, or up to $3,000 of ordinary income per year, with excess losses carrying forward.

The tricky part is that impermanent loss and actual market losses get mixed together. If ETH drops 50% while in the pool, your withdrawal value is lower due to both the market decline and impermanent loss effects. Separating these for tax purposes requires careful calculation of what you would have had if you simply held versus what the pool returned.

📉 Impermanent Loss Tax Treatment

Scenario	Tax Deductible?	Notes
Still in pool	No	Unrealized loss
Remove at loss	Yes	Capital loss realized
Fees earned > IL	Net gain taxed	Offset by income

🎫 LP Tokens — Tax Treatment Explained

LP tokens represent your share of a liquidity pool. They are tradeable assets with their own cost basis and holding period. Understanding how LP tokens are taxed is crucial because they are the bridge between depositing assets and eventually withdrawing them.

When you receive LP tokens, their cost basis equals the fair market value of the assets you deposited. If you deposited $30,000 worth of ETH and $30,000 USDC, your LP token cost basis is $60,000. The holding period for LP tokens starts fresh from the deposit date, regardless of how long you held the underlying tokens.

Staking LP tokens in farming protocols generally does not trigger a new taxable event. You are depositing LP tokens as collateral, not exchanging them. However, the rewards you earn from staking are taxable income. When you unstake, you get back the same LP tokens with the same cost basis — no gain or loss from the staking itself.

Selling or transferring LP tokens triggers capital gains tax. If someone offers to buy your LP position directly, the difference between the sale price and your cost basis is a capital gain or loss. This is relatively rare since most people simply remove liquidity, but it happens in OTC deals and certain protocol migrations.

🎫 LP Token Cost Basis Tracking

Action	LP Token Basis	Holding Period
Deposit $60K to pool	$60,000	Starts new
Stake LP in farm	$60,000 (unchanged)	Continues
Unstake LP	$60,000 (unchanged)	Continues
Remove liquidity	Compare to withdrawal value	Gain/loss realized

⚠️ 2026 brings new reporting requirements

Exchanges will send 1099-DA forms to the IRS. DeFi still requires self-reporting.

🔍 1099-DA Crypto Tax Form 2026

📝 DeFi Record Keeping — What to Track

DeFi record keeping is more demanding than any other area of crypto taxation. Without centralized exchanges providing transaction histories, you must maintain your own comprehensive records. The IRS recommends keeping records for at least seven years, but with DeFi, I suggest keeping them indefinitely because cost basis calculations can depend on transactions from years ago.

For every DeFi transaction, you need to record: the date and time, the protocol used, the type of transaction (deposit, withdraw, swap, claim), the tokens involved with quantities, the fair market value in USD at that moment, the transaction hash, and any gas fees paid. Gas fees are deductible as part of your cost basis or as investment expenses depending on the transaction type.

Block explorers like Etherscan, BscScan, and Polygonscan are essential tools. They provide permanent records of every on-chain transaction. Export your transaction history regularly and save it in multiple locations. Protocols can shut down and block explorers can change formats, so do not rely on being able to access this data later.

Crypto tax software has become essential for DeFi users. CoinTracker, Koinly, and TaxBit can import wallet addresses and automatically categorize DeFi transactions. They calculate cost basis, track LP token movements, and generate tax forms. The software is not perfect and often requires manual corrections, but it is far better than trying to track everything in spreadsheets.

📝 DeFi Record Keeping Checklist

Data Point	Required?	Source
Transaction hash	Yes	Block explorer
Date and time (UTC)	Yes	Block explorer
Token amounts	Yes	Block explorer
USD fair market value	Yes	Price API / CoinGecko
Gas fees	Yes	Block explorer
Protocol name	Recommended	Your records

🚨 Avoid IRS audit triggers

Learn what red flags the IRS looks for in crypto returns.

🔍 IRS Crypto Audit Red Flags 2026

❓ FAQ

Q1. Is adding liquidity to a pool a taxable event?

A1. Most tax professionals treat it as taxable. You are exchanging your tokens for LP tokens, which triggers capital gains on any appreciation in the deposited assets.

Q2. How are yield farming rewards taxed?

A2. Yield farming rewards are ordinary income at the fair market value when received. This can be taxed up to 37% federal plus state taxes. When you later sell those reward tokens, capital gains tax applies to any appreciation.

Q3. Can I deduct impermanent loss on my taxes?

A3. Not directly while in the pool. Impermanent loss only becomes a deductible capital loss when you remove liquidity and realize the loss. The actual loss amount depends on the difference between your LP token cost basis and withdrawal value.

Q4. Do auto-compounding vaults create taxable events?

A4. Yes. Each time the vault harvests and reinvests rewards, it creates a taxable income event. Some vaults compound multiple times daily, creating hundreds of taxable events per month. Crypto tax software is essential for tracking this.

Q5. What is the cost basis of LP tokens?

A5. The cost basis equals the fair market value of assets you deposited to receive the LP tokens. If you deposited $30,000 ETH and $30,000 USDC, your LP token basis is $60,000.

Q6. Does staking LP tokens trigger a taxable event?

A6. Generally no. Staking is treated as depositing collateral, not a disposal. Your LP token cost basis and holding period continue unchanged. However, any rewards earned from staking are taxable income.

Q7. How long should I keep DeFi records?

A7. The IRS recommends at least seven years. For DeFi, I recommend keeping records indefinitely because cost basis calculations can depend on transactions from years ago, especially with LP tokens and complex farming strategies.

Q8. Will I receive a 1099 for DeFi transactions?

A8. No. DeFi protocols do not issue 1099 forms. Only centralized exchanges will send 1099-DA starting in 2026. You are responsible for tracking and reporting all DeFi transactions yourself.

📚 Related Articles

📄 Crypto Staking Taxes 2026 — How Staking Rewards Are Taxed

📄 NFT Tax Guide 2026 — Collectibles 28% Rate Explained

📄 1099-DA Crypto Tax Form 2026 — First Year Guide

📄 Best Crypto Tax Software 2026

📄 IRS Crypto Audit Red Flags 2026 — How to Avoid Getting Flagged

⚠️ Disclaimer

This article is for informational purposes only and does not constitute tax, legal, or financial advice. DeFi taxation is an evolving area with limited IRS guidance. Tax laws vary by jurisdiction and change frequently. Consult a qualified tax professional for advice specific to your situation. The author and publisher are not responsible for any actions taken based on this information.

Last Updated: December 28, 2025 | Sources: IRS Publications, IRS Virtual Currency FAQ, Revenue Ruling 2023-14

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