The 1031 Exchange requires you to take proceeds from a smaller asset to put into a larger asset. For example, you sell a single-family home and use the proceeds to buy a small apartment building. Assuming the latter is worth more, you can defer taxes. You can keep doing this as long as the next asset is larger. The problem with crypto is that it's divisible. So, the analogy doesn't hold.
One strategy that is possible is to pile savings into DeFi with the intent of never taking it out. You just continue borrowing and paying off the loan. You would benefit from capital gains without worrying about tax. This is what I have started doing. If I ever pulled out my deposits, I would end up with more than I added. However, as long as I don't withdraw, it continues to compound, increasing my credit line.
The only problem with this approach is if the DeFi platform upgrades or it becomes necessary to withdraw, such as getting hacked. Then, it forces a realization of the gain. Then again, it never gets converted to money.
With that line of thinking, there is no way, for example, for me to convert tMCDAI, tCRO, or tBTC to cash. I would have to convert to Wrapped DAI, WCRO, and WBTC first. Then, I could convert to WUSDC to bridge to the Exchange for USDC. And, finally, turn USDC to fiat. Or, I could convert the DeFi tokens to WBTC, bridge to the exchange, and sell WBTC for fiat. That's a long chain of transactions to realize a value. It's only a rumor of profit before the true profit comes out.
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It's not right to be taxed for an event you didn't initiate. If you withdrew your crypto for whatever reason under normal circumstances, then it can be taxed as normal; you chose to cash out, and you knew what the tax penalties were ahead of time.
Crypto withdrawals due to hacking cannot be taxed because the withdrawl (or cashing out) took place without your knowledge, and therefore without your consent. You didn't choose to "withdraw" or "cash out" in this case. In short, the crypto taken out was due to theft. Theft cannot be used as the basis for creating a taxable event.
I used the word "cannot" in the everyday sense of the word, but the legal context may or may not be different. This is up to a top-shelf crypto lawyer to present to the taxing authorities.
Sooner or later, legislation needs to be written and then signed into law which properly and ethically accounts for the hacking situation. If not for those reasons, then it should be included because any of the legislators (not to mention the chief executive and his/her staff) could fall victim to theft by hacking and we know they don't want to be taxed in that event.
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