Lending cryptocurrencies, borrowing fiat against your crypto holdings, and margin trading crypto are each treated differently.
Crypto lending is growing in popularity with companies like Salt and BlockFi. In short, investors can deposit their cryptos with these companies in exchange for interest payments. Interest payments for cryptos aren’t explicitly mentioned by the IRS, and it is assumed these payments would count as income, similar to mining income. Like mining, you will need to determine if you are operating as a business or a hobbyist (investor) and report your income accordingly. Importantly, if you are paid in crypto, you will be taxed at the fair market value of the coins received. This will be taxed at your income tax rate. Companies like BlockFi will send you the 1099-INT form, which the IRS uses to record interest payments.
Crypto-to-fiat loans have two components: the fiat from the loan and the interest payments. Taking out a fiat loan against your crypto holdings does not create a taxable event, as you are neither selling, trading, or exchanging the cryptocurrency. The interest, on the other hand, may be tax deductible. A tax deduction lowers the yearly tax liability by lowering total taxable income. Interest payments are deductible if the loan is for commercial purposes. Loans used for personal reasons aren’t usually tax deductible, but may be if the loan is used to purchase an investment asset.
Margin trading is a form of loan offered by an exchange (broker). The exchange lends you cryptocurrency to trade with for a fee and interest payments. Like crypto-to-fiat loans, this does not create a taxable event when you receive the coins. If at any point you sell the borrowed coins this would create a gain (or loss) and would be taxed as a capital gain (or loss). Make sure to understand what a margin call is, as this can force you to close your position prematurely, which would generate a taxable event. Last, the interest paid on the loan counts as an itemized deduction.