Crypto Loans and Taxes (DeFi Guide)

Cryptocurrency HODLers are increasing worldwide, and so are the number and types of borrowing and lending involving digital assets. The question of DeFi taxes keeps popping up as more people turn to crypto as an alternative way of earning passive income or taking advantage of cryptocurrency-backed loans

DeFi platforms are now popular not just from the crypto loan products they offer or investment point of view; there are attention-grabbing tax advantages. This article will analyze potential tax issues to help you understand the broad subject of crypto loan taxes and their implications.  

Do You Have To Pay Taxes On A Crypto Loan?

If, like most HODLers you believe in the long-term potential of cryptocurrency prices, you can raise cash through your digital assets without letting go of their potential profits. By joining DeFi platforms like SmartCredit.io, you can benefit from borrowing money at rates that are lower than what commercial banks charge for personal loans using your crypto as collateral. 

Taking crypto backed loans, just like borrowing money, is not a taxable event in most jurisdictions. This means, therefore, you can benefit from long-term capital gains taxes in the future when you decide to sell them. In the meantime, you can continue to keep your digital assets for long-term holding.

Let’s give a hypothetical example. You bought a single Bitcoin in December 2018 for $4,000, and how it’s valued at $63,000. You can place your Bitcoin as collateral, and a lender gives you a non-taxable fiat loan of $30,000.  You can employ your cash on any use cases for crypto loans and ensure you repay the $30,000 plans interest by the agreed period.There are chances that the price of Bitcoin could appreciate while it’s still held as collateral, but you won’t be liable to pay any taxes.

You can borrow fiat currency against your cryptocurrency holding any time and rest easy without worrying about tax liabilities. This is because crypto-backed loans are similar to collateralizing your property with a bank and getting cash against your equity. This means therefore, if you plan correctly, you can get liquidity on your cryptocurrency investment without paying capital gains taxes.

Are There Situations When You Have To Pay Taxes On Crypto Loans?

Yes, there are times when you could pay crypto loan taxes.

First is a situation where you failed to repay the loan as agreed due to poor planning or some other reason. The lender will be free to liquidate the collateral to mitigate their losses. The liquidation event will create a capital loss or gain event for you.

Let’s say you spent the $30,000 you borrowed to buy a new car, and you cannot repay the loan. Suppose, on the last day, you should have reimbursed the loan Bitcoin is trading at $70,000. Should the lender liquidate your Bitcoin, they’ll subject you to a $63,000 ($70,000 – $7,000) capital gain. As you can see, then, defaulting on a crypto loan puts you on a path where you’ll be forced to pay capital gains taxes.

The second scenario where crypto lending tax could apply involves liquidation as a result of price volatility. DeFi lending protocols set certain thresholds below which the price of a collateralized cryptocurrency shouldn’t fall. This, in the case of non-custodial DeFi platforms like smartcredit.io, is meant to protect the interests of the lender and the platform from losses. The only way you can save yourself from falling into liquidation and the obligations of the attendant taxes are to pay off the loan immediately or provide additional collateral.

How Are Crypto Loans Taxed?

While borrowing fiat currency with your digital assets as collateral doesn’t attract tax liabilities, the interest you accumulate for using the cash for a commercial pursuit can be treated as a tax-deductible expense. If, for example, you used the crypto loan to buy a piece of property that will provide investment income, the interest you earn from your investment is taxable.

Using your crypto-backed loan for margin trading is likely to attract crypto loan taxes. We’ve already learned that taking the crypto loan itself isn’t taxable, but the gains or losses you incur from selling any property you buy are considered a taxable event.

The interest you earn in cryptocurrency will be subject to capital gains. In the case of margin trading, you’re considered to have sold when you close a position. Any gains or losses that you’ll make at that point are considered capital loans or losses, and you’ll need to declare them the same way as with other regular trades.

Suppose you took a crypto-backed loan and bought long. Let’s say you borrowed $60,000 from a lender you met through smartcredit.io and bought one Bitcoin. If the price increases and you gain after selling the crypto, your profit becomes a taxable event subject to a capital gain tax.

Suppose after several days, the price of Bitcoin increases to $65,000. You’ll sell the Bitcoin and repay the $60,000 you borrowed from the lender. The $5,000 you earned is subject to capital gains tax. If you pay the lender $500 as interest, the amount will be deducted from your profit as an expense, meaning that $4,500 will be treated as the tax rate.

Tax Deduction and Crypto Loans

If you’ve read this guide so far, you must have noticed the many tax advantages associated with crypto-backed loans. You can avoid paying DeFi taxes by using your digital assets to borrow the same kind of token. For example, you can join SmartCredit.io, put your cryptocurrency up as collateral, and borrow a Stablecoin, which you can convert into fiat currency.

You only need to make sure that you repay your loan on time so that your collateral is not liquidated or exchanged, then you’ll not trigger any crypto lending taxes. You can only get worried about DeFi taxes if the value of your collateral depreciates tremendously or when the value of the crypto you borrowed surges exponentially, as it could trigger a margin call or liquidation.

If that happened, it could appear like you sold your cryptocurrency for fiat, and you could realize the capital loss or gain on your assets. Just remember that joining SmartCredit.io and putting up your digital asset as collateral will not attract any crypto loan taxes.