RE: Tax AMA - 2018 Tax Season - Ask Me Anything

[smithgift]

There are tons of people who are curious about the tax consequences of opening/using a Maker CDP. It's one of the most common questions asked on /r/makerdao and the Maker Rocket Chat. Although I don't have any CDPs, I've been curious myself.

The technical steps are as follows:

1. Wrap your ETH into WETH, which I argue should probably not be a taxable event. (They have the same economic properties, just different technical ones)
2. Wrap your WETH into PETH (Pooled ETH) which is a token representing a share in all the collateral that the MakerDAO system has. Since the pool can grow or shrink, and thus has different economic properties, I'm thinking this is a taxable event. I've heard arguments against that, though.
3. Lock your PETH into a CDP. This is probably not a taxable event.
4. Take out a DAI loan from the CDP. Here's where my layman's knowledge ends. I would hope that it's legally considered a loan, but it's not in USD, or even technically a currency.
5. Repay the loan, which requires briefly purchasing MKR to pay the interest on it. Also, the effective principle will have fluctuated--you might have taken out the loan when DAI was trading at $1.02, and now it's $0.97.

This is not counting the possibility of one's collateral falling in value, whereupon some or all of it will be repossessed by the system. I'm sure there's something in the tax code somewhere about this sort of thing, but I haven't a clue where.

EDIT: Also, can you deduct the interest on the CDP--say, if it was owned by your business?

Comments

[cryptotax]

Based on the description, this is what I would think (but I would need to review the terms 100% to be certain on this). Below is from the perspective of the borrower itself.

• I would say ETH-WETH is a non-taxable event if WETH is an alternative digital representation of ETH and they trade in/out 1 for 1. No property has actually been sold.
• I would say WETH-PETH-CDP is a security deposit. If the borrower would end up with more/less ETH when withdrawing - deemed loss of ETH or realized gain for free ETH . The loss would be nondeductible if the purpose of the loan is non-investment, non-business ( is personal loan collateral).
• The existence of a loan for U.S. tax purposes would depend on whether there is set maturity dates, interest payments, recourse against borrower. Let's assume this applies. For more reading check out Roth Steel Tube Company V. Comm. Sounds like a loan on the surface.
• Repaying the loan at a USD premium could be treated as deductible original issue discount on the loan for the issue price versus redemption payment difference (if the loan is personal this is not deductible). However, re-payment of the DAI loan at a discount could trigger cancellation of debt income. All other stated interest is potentially deductible (unless personal).

See disclaimer above in original post (but you already knew that!).

[smithgift]

Thanks for the in-depth answer.

• ETH-WETH is definitely traded in/out 1 for 1.
• Interesting about PETH. Considering that some people are facing potentially massive capital gains by opening a CDP with early-bought ETH, it'd be worth it for them to consult a professional to be sure.
• Even more interesting, CDPs sorta fit two out of those three. There is definitely interest, which can be paid at any time, and if the collateral falls in value, it will be seized. But there's no set maturity date. Which makes me wonder if it's not a loan, and instead just a fancy margined long position.

If you're curious, the Maker team goes into more detail in its whitepaper: https://makerdao.com/en/whitepaper The Maker team itself has not released any tax guidance of its own, for understandable reasons.

[cryptotax]

I will have to look into this, it is fascinating. I would argue that a margin call is a maturity date and liquidation of positions would give rise to taxable events. Margin interest in typical investing is deductible.