Understanding Wrapped Tokens

Cryptocurrency enthusiasts are continually exploring new ways to interact with blockchain networks, and one such innovation is crypto wrapping. Wrapping is a process that involves tokenizing a cryptocurrency to make it compatible with specific blockchain networks and allows us to leverage those assets in DeFi activity. While this provides greater flexibility and access to DeFi applications, it also brings tax implications. In this guide, we'll delve into the intricacies of crypto wrapping, introduce a new categorizing system, and explore the tax treatment options for wrapped assets.

Categorizing a Transaction as Wrap

To facilitate accurate tracking and reporting of wrapped cryptocurrency transactions, a new tagging system is introduced. Users can now change the transaction Category to 'Wrap' for Trade transactions.

Use the 'Wrap' category on transactions where:

• you tokenize a cryptocurrency, turning it into a wrapped version suitable for specific blockchain networks and activities.
• you unwrap a token, converting it back to its original form.

Tax Treatment of Wrapping

By default, transactions categorized as “Wrap” are treated as taxable events, much like traditional trades.

However, users can configure their settings to treat “Wrap” transactions as non-taxable in the settings page, here (see last section of this help doc for more details).

When marked as non-taxable:

1. Transfer of Cost Basis: the cost basis of the outgoing token is transferred to the incoming token. This ensures that the original purchase details are retained.
2. Acquisition Dates:
   • Single-In-Single-Out (SISO) Transactions: The acquisition date of the outgoing token transfers to the incoming token.
     • Let’s say we bought ETH on 1/1/22, then wrapped that ETH on 1/10/22, and received WETH.
       • The date acquired for WETH on our 8949 tax form would be 1/1/22, not 1/10/22.
     • Later we traded 0.5 WETH for an NFT on 2/1/22:
       • The date acquired for the 0.5 WETH would be 1/1/22, not 1/10/22.
     • We also unwrapped 0.5 WETH for 0.5 ETH and sold that 0.5 ETH on 2/1/22:
       • The date acquired for the 0.5 ETH would be 1/1/22.

• Multiple-In-Multiple-Out (MIMO) Transactions: The transaction date becomes the acquisition date for the incoming tokens.As an example:
  • Let’s say we bought 1 ETH and 1 cbETH on 1/1/22, then wrapped both quantities of ETH and cbETH on 1/10/22, and received WETH.
  • Later we unwrapped WETH on 2/1/22 and received 2 ETH back and sold it the same day:
    • The date acquired for the 2 ETH will be 1/10/22, not 2/1/22.

Changing default Tax Treatment for Wrapping

Wrap taxation

By default, transactions tagged as “Wrap” are treated as taxable events, much like traditional trades.

1. However, users can configure their settings to treat “Wrap” transactions as non-taxable in the settings page, here.
   
2. When configuring this setting, users are asked for an effective date, which is crucial for tax purposes. Any transactions marked as wrap after this date will not be treated as taxable events.
   1. The default date is set based on the user's country's tax year.
   2. For example, a US user configuring this setting on April 15, 2023, would see the option to set the effective date as January 1, 2023, as the US tax year runs from January 1 to December 31.
3. Turning Off the Setting: Users can choose to turn off the non-taxable setting and provide an end date if needed.

In Summary, crypto wrapping is an exciting development in the blockchain space, enabling users to participate in various DeFi applications. However, it's essential to understand the tax implications of wrapping and to have the flexibility to customize your settings according to your preferences. CoinTracker's new tagging system and tax treatment options make this process more manageable, ensuring that you can confidently navigate the world of wrapped assets.