Is wrapping crypto taxable? (2024)

Wrapping crypto may be a taxable event in the US, even though there’s currently no official tax guidance from the IRS about taxes for wrapping tokens.

But, first, what are wrapped tokens, and why should you consider them?

Today, we’ll cover if wrapping crypto is a taxable event, explore its implications, and simulate different tax scenarios assuming that wrapping crypto is taxable.

What is a wrapped asset?

Wrapped assets are tokenized crypto assets under a different Blockchain.

For example, you wrap (tokenize) Bitcoin on the Ethereum Blockchain, resulting in Wrapped Bitcoin (wBTC).

What is the purpose of wrapped coins?

The main advantage of wrapping an asset is giving more flexibility and cost efficiency to trade between cryptocurrencies running on different networks.

Wrapping tokens increase crypto’s interoperability since you can trade wBTC in an Ethereum-based exchange like Uniswap while increasing your Bitcoin portfolio.

This is true for many other platforms, hence the rapid increase in popularity, especially for more sophisticated traders, of wrapping assets and trading in decentralized exchanges.

Is wrapping a token taxable?

Yes. Wrapping tokens is a crypto-to-crypto trade, a taxable event in the US, subject to capital gains taxes.

Crypto trades, for FIAT (USD) or another cryptocurrency, are taxable events in the US. This is also true when converting a cryptocurrency like Bitcoin to a stablecoin (e.g., USDT). You’ll still have to report the gain on the transaction and pay the appropriate capital gains taxes.

Many compared wrapped assets to stablecoins since if you buy 1 Bitcoin and want to wrap it, you’ll have 1 wBTC, which is practically worth the same. According to usual rates on popular exchanges, 1 Bitcoin is usually worth between 0.9980 to 1.002 wBTC, so your gain on the trade involving wrapped assets may be just cents, but you still have to determine the gain and report the trade.

However, if the FMV of BTC at the time of your conversion to wBTC is very different from your cost basis in the BTC, you may experience a significant gain or loss.

Is wrapping your Bitcoin a taxable event?

In our view, wrapping Bitcoin for wBTC is a taxable event because although the FMV of wBTC is usually about the same as that for BTC, wBTC and BTC are two different coins. As a result, the conversion between wBTC and BTC is considered a crypto-to-crypto trade, subject to capital gains taxes. As such, wrapping any crypto is a taxable event in the US.

Let’s see it clearly in a tax simulation.

Let’s imagine that Sarah bought 1 Bitcoin for $20K in December 2020. In April 2021, 1 Bitcoin was worth $60k. Sarah wants to start using decentralized exchanges (Ethereum-based), but she wants to trade against Bitcoin. As a result, she decides to wrap her Bitcoin.

An exchange between Bitcoin and wBTC is essentially a crypto-to-crypto trade. Sarah’s cost basis in BTC is the price she paid for 1 Bitcoin in December 2020 ($20K). Her sales proceeds are the fair market value of the wBTC she is now buying. In this case, 1 BTC equals 1.001 wBTC, where 1 BTC is worth $60K.

As a result, the total sales proceeds are $60,060 ($60K*1.001 wBTC). The capital gains are the difference between the sales proceeds and the cost basis. In this case, the capital gain will be $40,060 ($60,060-$20,000). Since Sarah is selling before holding her Bitcoin for at least 12 months, the capital gains will be subject to a short-term tax rate, ranging between 10% to 37%, depending on other factors.

If you hold crypto for more than 12 months, you’ll get a tax benefit by getting a long-term capital gains tax rate in the US, which is lower than the short-term capital gains tax rate. There are many tax benefits in other countries when holding crypto for at least 12 months as well.

Is wrapping ETH taxable?

Wrapping ETH follows the same underlying guidance of wrapping Bitcoin. Those operations are considered a crypto-to-crypto trade, a taxable event in the US, and subject to capital gains tax.

Is wETH to ETH conversion taxable?

Converting wETH to ETH is a taxable event. Once you’ve wrapped your Ethereum and you want to convert it back to ETH, the logic for calculating capital gains is the same as in the tax simulation above for wrapped Bitcoin.

Decentralized exchange taxes

Wrapping tokens is one of the trends supporting the popularity of decentralized exchanges, where many operations are taxable events.

If you trade in a decentralized exchange, you’re swapping tokens, meaning you are trading one crypto for another crypto. In the US, crypto trades in a DEX are taxable events, subject to capital gains taxes.

Moreover, providing liquidity to pools in decentralized exchanges, gaining rewards from yield farming, or gaining tokens from a decentralized exchange airdrop are all taxable events.

Check out our DeFi taxes guide, covering all the tax details for those decentralized exchange operations.

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How do I avoid crypto taxes?

In the US, you can reduce your crypto taxes by donating crypto, long-term holding, investing crypto in retirement plans, moving to a crypto tax-friendly country, moving to a crypto tax-friendly state, utilizing crypto tax loss harvesting, and more. Check out this guide on how to reduce crypto taxes.

You can use strategies to offset your capital gains and avoid some crypto taxes, but you still must follow all the official crypto tax guidelines. In any case, you can’t avoid the reporting requirement for crypto trading and follow the IRS guidelines for reporting your crypto activities (e.g., crypto trades, earning interest, staking rewards, airdrops, hard forks, etc.).

How do I report wrapped tokens on my taxes?

Now that we’ve seen that wrapping crypto is a taxable event, let’s explore how to report them on your taxes.

In the US, you must report your crypto gain/loss from each trade you make. If you swap tokens, you must report it just like all your crypto trades in the tax year. As a result, you need to calculate gain/loss on each of those trades and report them on your tax returns to be compliant.

If you’re using DEXs to wrap tokens, you can import your trades by using your ETH or BSC addresses and a crypto tax software like CoinTracking to calculate your gains/losses and help you file your tax returns in your country. For more clarification, check our guide on how to report your crypto taxes.

How to do your wrapped token taxes?

1. Import your wrapped token trades from popular exchanges.
2. Get your capital gains automatically calculated from your wrapped token trades, according to FIFO, HMRC, and 10 other accounting methods.
3. Generate compliant tax returns to become tax compliant.

The best DeFi tax calculator: CoinTracking

CoinTracking covers all your DeFi needs. Our crypto tax software makes it easy to import your wrapped assets trades, get your gains calculated, and generate the appropriate tax reports.

Additionally, If you’re an active trader on decentralized exchanges, you can easily import all your Ethereum and Binance Smart Chain-based trades from Uniswap, 1inch Network, SushiSwap, or PancakeSwap into CoinTracking. You can simply paste your ETH or BSC address into CoinTracking and import your trades and get your gains automatically calculated.

Moreover, CoinTracking can easily classify all your earnings from crypto staking, liquidity pools, earning crypto interest, and more, including:

1. Importing (API & CSV) your trades from 110+ exchanges/wallets.
2. 25+ advanced reports, including which coins offer you a tax-free rate.
3. Automatic capital Gains, according to 12 accounting methods (e.g., FIFO, LIFO, HMRC, ACB), accepted worldwide.
4. Generate complete Tax Reports in your country.

Do you have any crypto tax questions? Check our Full Service in the US

CoinTracking also offers a full service for US traders. A crypto reconciliation tax expert from Polygon Advisory Group, a leading US crypto tax firm, will review your CoinTracking account, help fix any errors, and ensure you submit your crypto tax reports error-free.

This can be particularly useful on grey-area matters such as taxes concerning wrapping assets, liquidity pools, yield farming, and others where the tax guidance is still emerging.