wBTC and other Wrapped assets

I’ve read that conversion from BTC --> wBTC and the like doesn’t trigger a capital gain and that tyhe previous cost basis can carry over, is that a reasonable expectation? Assuming the same applies for things like ETH -->wETH.

Perhaps slightly different, would using BTC to directly trade for wBTC on an exchange like Coinbase be any different?

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This is a grey area without any clear guidance from the IRS so there are two interpretations:

  1. It’s a taxable crypto-to-crypto trade (conservative position)
  2. It’s a non-taxable swap (new coin takes on the cost basis and holding period of the original coin)

You should connect with your tax advisor on how to handle these.

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Is there an existing work around for tracking for minting WBTC from BTC? Any idea on timeline for automatically tracking?

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To match up the two sides of the transaction: edit the BTC send transaction to make it a trade for WBTC in the appropriate wallet. Then mark the separate (now duplicated) receive WBTC as ignored. This is similar to the ICO transfer matching steps.

Long term: tracking a resolution for this.

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Thank you, Chandan. Much appreciated.

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It’s similar to exchanging one stable coin for another in the eyes of the IRS. Even when both stable coins are $1 or 1 to 1. I would say you still have to track the cost basis like you do with stable coins. The difference with a coin that moves in value is that you are going to trigger a taxable event. For example, if you bought your BTC for 48,500.15 then converted it to wBTC for 48,500.15 you would have no taxable event as it’s the same price. However for example, if you bought BTC at 48,500.15 and converted it later to wBTC at 51,810.50 you would end up with a taxable event of 3,310.35 since the price of Bitcoin moved up. On the plus side, it may also trigger losses if the price of Bitcoin went down, which you could claim.

This is basically how I see it getting taxed and how the current tax code is written. I don’t see it being safe to do it the other way as I don’t think it follows the IRS tax codes. The only way that changes is if the IRS clarifies differently how DeFi tokens are taxed. Or creates a new law where swapping the wrapped tokens in the DeFi space doesn’t trigger a taxable event.

What I think you are confusing this with is in regards to Token Swaps. This would only happen in cases like where EOS ERC-20 token was swapped for mainnet coins and the ERC-20 token was deprecated. In this case, it would be treated like what happens when your stock goes through a merger or acquisition, in which you end up with new shares of something else. The IRS does not look at the event as a taxable transaction cost basis from old shares carry over to the new ones.

I have been reading more about wrapped tokens. This is a very grey area and I wanted to add some addition points. Let’s ignore wrapped tokens for a second and just look at asset or crypto backed tokens. If you are buying a stable coin or what I would call an asset or crypto backed token, then these tokens I would treat exactly how I mentioned in my last post. These asset and crypto backed tokens are essentially pegged tokens that are pegged to an asset like Bitcoin ETH, USD, or Gold, I would say these are kind of like ETFs. And even though they are pegged and track similarly with small deviations, swapping between them would absolutely be taxable.

The grey area comes in when you are swapping into a wrapped token. In fact I wouldn’t even call it swapping. Upon further reading about wrapped tokens it would appear that it’s a very complex derivatives contract. Basically it sounds like you lock up Bitcoin or ETH into a contract that then issues a Token on deposit for that amount of Bitcoin or ETH you put in as a token in a smart contract. This to me is similar to taking USD in the form of cash and putting it into a bank, you then get digital USD on deposit. I have no idea what the implications of this are.

I hate this but we are going to have to wait for further guidance on this. And it’s very frustrating if they decide something later on and retroactively apply it. Simply for the fact that you will have to go back and amend all your tax returns that this effects since the ruling differs in how your return was filled out. I could see several other changes as well. I think the biggest change was in 2017 or only in 2019, where the IRS issued guidance on specific identification for cost basis. Until then it was assumed that you could only use FIFO. This is less then ideal. Every time they do this you will have to amend your tax returns. I can’t even imagine amending the same year 3 or 4 times. I would like to not think about it.