Impermanent Loss: What it is and When You Can Claim a Deduction
Impermanent Loss: Can You Claim a Deduction?
Analyzing whether LP divergence qualifies as a realized loss for tax purposes
Impermanent Loss in a Nutshell
When you supply two tokens to an automated-market-maker (AMM) like Uniswap or Curve, you receive LP (liquidity-provider) tokens that track your pro-rata share of the pool. If the market price of the pair drifts while your funds sit in the pool, the mix of tokens re-balances. Compared with simply “HODLing,” this means you end up with fewer of the appreciating token and more of the depreciating one. This is loss of tokens is known as impermanent loss (IL).
It is “impermanent” because the divergence may close, or trading fees may offset it, before you withdraw. The amount of IL your investment has accrued can go up or down as either or both of the tokens in the pool fluctuate in value. Therefore, the loss remains “impermanent” until you close the position in the pool, at which point the loss is realized (or permanent).
Realized vs. Unrealized: Where the IRS Draws the Line
The IRS taxes crypto as property, so a deductible capital loss requires a closed and completed transaction (a sale, swap, or other disposal). Merely watching a token’s value fall (or an LP position diverge) is not enough. The Taxpayer Advocate Service reiterates this principle: you cannot claim a loss “until there is a closed and completed transaction, such as a sale or exchange.”
Does Impermanent Loss Itself Trigger a Deduction?
No. While your dashboard may show a negative IL figure, nothing is realized while your LP tokens remain untouched:
Action | Tax treatment (U.S.) |
Deposit tokens & receive LP tokens | Often treated as a taxable swap (you’ve exchanged the original assets for a new asset—the LP token). Character: capital gain or loss determined by the FMV of the LP token received. |
Price divergence while funds stay in the pool | Unrealized. No deduction available; IL is only theoretical. |
Withdraw liquidity (redeem LP tokens) | Disposal of LP tokens. Calculate proceeds (FMV of tokens received) minus cost basis of LP token to get the capital gain or loss. At this moment, any IL becomes permanent and deductible. |
Calculating the Deductible Loss
Establish the cost basis for LP tokens (usually the FMV of tokens you originally deposited, plus any protocol fees you paid).
Record the proceeds (total value of the principal deposit) when you burn LP tokens and receive the underlying assets.
Compute gain/loss = Proceeds – Cost basis.
Report on Form 8949 and flow totals to Schedule D.
Short-term vs. long-term treatment depends on how long you held the LP token (how long your deposit remained in the pool), not the underlying tokens.
Tip: If your withdrawal results in a net capital loss for the year, you can offset unlimited crypto (or stock) capital gains and up to $3,000 of ordinary income, carrying any remainder forward indefinitely.
Edge Cases & Common Questions
Scenario | Deductible? | Why |
Partial withdrawals / “zap” out of one side only | Yes, pro-rata. Each disposal of LP tokens (or receipt tokens) is a realization event. | |
Auto-compounding vaults that continuously stake LP tokens | Each reinvestment cycle may reset the cost basis; having good software is essential. | |
Impermanent loss hedging products (e.g., IL insurance, range pools) | Premiums paid may be an investment expense; payouts are income. Track separately. | |
Foreign jurisdictions | Canada, UK, Australia, and most EU countries mirror the “dispose = taxable, hold = unrealized” rule, though terminology differs. Always verify local guidance and consider consulting a CPA. |
Record-Keeping Best Practices
Export on-chain transactions (deposits, withdrawals, fee rewards) in CSV.
Tag LP-token mints/burns distinctly in your crypto-tax software.
Note any protocol incentives received while farming; these are typically treated as ordinary income when credited, regardless of income level (IL).
Key Takeaways
Impermanent loss is not deductible while it’s still impermanent.
The deduction materializes only when you dispose of LP tokens (or a derivative receipt token) and lock in the divergence.
At withdrawal, treat the transaction like any crypto trade: calculate capital gain or loss, report it, and—if it’s a loss—apply it against other gains or up to $3k of income.
Due to the complexity introduced by AMM math, vault auto-compounding, and protocol rewards, robust tracking tools and professional advice are highly recommended.
Bottom line: You can’t write off a “what-if.” Wait until the IL becomes permanent—then you may be able to harvest it just like any other realized crypto loss.
Awaken does all of this work for you. We automatically track your cost basis and capital gain/loss of your LP tokens, so you don’t have to worry about running these calculations.
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