Yield Farming Tax Implications in the US: What You Need to Know in 2025

Yield farming sounds like free money. You lock up your crypto in a protocol like Uniswap, Aave, or PancakeSwap, and suddenly you’re getting paid in tokens-sometimes even more than you put in. But here’s the catch: yield farming isn’t free. The IRS sees every reward as taxable income, and if you don’t track it, you could owe thousands-or worse, trigger an audit.

Every Reward Is a Taxable Event

When you earn interest, fees, or new tokens from yield farming, the IRS treats it like getting paid in cash. It doesn’t matter if you never sold anything. The moment those tokens hit your wallet, you owe taxes. This applies to:

• Interest paid in ETH, USDC, or any other token
• Protocol-native tokens like COMP from Compound or SUSHI from SushiSwap
• Liquidity provider (LP) tokens that later earn rewards
• Any token received as a bonus for staking or providing liquidity

Let’s say you deposited $5,000 worth of ETH into a Uniswap liquidity pool and earned 0.5 ETH as a reward. If that 0.5 ETH was worth $1,800 on the day you received it, you just added $1,800 to your taxable income-even if you didn’t touch it. That’s not capital gains. That’s ordinary income.

Ordinary Income vs. Capital Gains: The Big Difference

This is where most people get tripped up. The IRS doesn’t care that you’re in DeFi. It treats crypto like property. So when you get a reward, it’s taxed as income at your regular rate. For 2025, that’s between 10% and 37%, depending on your total income.

But here’s the twist: when you later sell or trade those farming rewards, you might owe capital gains. That’s a separate tax event.

Example:

1. You earn 10 SUSHI tokens worth $300 on January 15, 2025. You pay income tax on $300.
2. You hold them until March 10, 2026, when they’re worth $600. You sell them. Now you owe capital gains tax on the $300 profit.

If you held the SUSHI for less than a year, that $300 profit is taxed as short-term capital gains-at your regular income rate. If you held it over a year, it’s long-term capital gains, taxed at 0%, 15%, or 20%, depending on your income.

What About LP Tokens? Are They Taxable?

Liquidity provider tokens are tricky. When you deposit ETH and USDC into a pool, you get LP tokens back. The IRS says that depositing crypto into a liquidity pool is not a taxable event-as long as you don’t swap or trade anything. But once those LP tokens start earning rewards, those rewards are taxable.

So if you get 0.2 ETH in rewards from your LP position every week, that’s $800 in income per month if ETH is at $4,000. You don’t need to sell the LP tokens. You don’t even need to withdraw. Just receiving the reward triggers the tax.

Valuation: The Hardest Part

The IRS says you must report the fair market value (FMV) of each reward in USD at the exact time you receive it. Sounds simple-until you’re getting paid in a new token that just launched on a decentralized exchange with no price on CoinGecko.

Here’s what actually works:

• If the token trades on a major exchange (Coinbase, Binance, Kraken), use that price.
• If it trades only on a DEX like Uniswap, use the average price across major pools at the time of receipt.
• If there’s no clear price, use the value of the crypto you put in to earn it. For example, if you deposited $1,000 worth of tokens to earn 100 new tokens, and those 100 tokens are worth $500, use $500.

Don’t guess. Don’t use the price from the next day. Use the timestamped price from the blockchain transaction. Tools like Koinly and CoinTracking pull this data automatically from your wallet.

Record-Keeping Is Non-Negotiable

You can’t rely on your exchange statements. DeFi doesn’t give you 1099s. You’re on your own. Every single reward, every swap, every deposit, every withdrawal-you need a record.

Here’s what you must track:

• Date and time of each reward receipt
• Token type and amount received
• USD value at the exact moment of receipt
• Transaction hash (for audit proof)
• Which protocol you used

Active yield farmers doing this manually spend 3-5 hours a week just logging transactions. That’s why most serious farmers use crypto tax software. These tools connect to your wallet, read your blockchain history, and auto-calculate your taxable events. They’re not perfect, but they’re the only way to avoid errors.

What the IRS Is Watching

The IRS has been targeting crypto since 2019. In 2025, they’re focused on DeFi. They’ve partnered with blockchain analytics firms like Chainalysis and Elliptic to trace wallet activity. They’re cross-referencing data from centralized exchanges with on-chain activity.

If you earned $5,000 in yield farming rewards in 2025 and didn’t report it, they’ll find it. And when they do, you’ll face penalties-25% of the underpaid tax, plus interest. For someone who earned $20,000 in rewards and paid nothing, that’s $5,000 in penalties alone.

There’s no amnesty program. No grace period. The IRS treats crypto like any other income. If you’re filing a 1040, you need to report DeFi income on Schedule 1, line 8z.

Estimated Taxes Are Required

If your total crypto-related income (including yield farming) pushes you to owe $1,000 or more in taxes for the year, you must pay quarterly estimated taxes. For 2025, the deadlines are:

• April 15, 2025
• June 17, 2025
• September 15, 2025
• January 15, 2026

Skipping these can cost you 0.5% per month in penalties. That adds up fast. If you earned $15,000 in yield farming rewards, you should be setting aside 25-35% of that for taxes. Don’t wait until April.

What Experts Say

Tax attorney Andrew Gordon, who specializes in crypto law, says: “The safest approach is to treat all yield farming rewards as ordinary income. If the IRS later says some of it was capital gain, you can amend your return. But if you treat income as capital gain and they disagree, you’re in trouble.”

Companies like Koinly and CoinTracking have analyzed millions of DeFi transactions. Their data shows that over 87% of yield farming rewards are classified as ordinary income by tax professionals who follow IRS guidance.

The bottom line: Don’t try to outsmart the system. The rules are clear. The enforcement is real. The tools exist. Use them.

What You Should Do Right Now

If you’ve done any yield farming in 2025, here’s your checklist:

1. Export all wallet transactions from your DeFi protocols (Uniswap, Aave, etc.)
2. Connect your wallet to a crypto tax tool like Koinly or CoinTracking
3. Review every reward transaction and confirm the USD value at receipt
4. Calculate your total ordinary income from farming
5. Set aside 25-35% of that amount for taxes
6. File your 2025 taxes by April 15, 2026, including Schedule 1

Waiting until the last minute is how people get audited. The complexity isn’t the problem. The delay is.