Borrowing against your crypto isn't taxable. Getting liquidated is.

There is a strategy that has become close to standard advice in crypto: do not sell, borrow. Selling triggers a taxable disposal. Borrowing against your holdings gives you cash while you keep the coins and keep the upside. The logic is sound, and for the most part the tax treatment supports it. The problem is what happens at the other end, in the scenario nobody plans for.

Why borrowing instead of selling appeals

If you sell crypto that has appreciated, you create a disposal and a gain you have to report. If you borrow against it instead, you get liquidity without that event. You post crypto as collateral, receive cash or stablecoins, and your position stays intact. For someone holding a large unrealised gain, the appeal is obvious.

Taking the loan is generally not a disposal

This part is good news and it is fairly settled. Borrowing money is not income, and posting collateral is generally not treated as selling it, because you have not given up ownership. In both Canada and the United States, drawing a crypto-backed loan is generally not a taxable event on its own.

So far the strategy works exactly as advertised.

Liquidation, however, usually is a disposal

Here is where it turns. If the price of your collateral falls far enough and the lender liquidates it to cover the loan, that liquidation is generally treated as a disposal of your crypto. You did not choose to sell, but for tax purposes a sale is what happened. The gain or loss is measured the same way any other disposal would be, against what you originally paid.

The trap: a taxable sale with no cash attached

This is the part that catches people hardest. When your collateral is liquidated, the coins go to the lender to settle the debt. Nothing arrives in your bank account. But if those coins were still worth more than you paid for them, there can be a reportable gain anyway.

So you can end up owing tax on a sale you never decided to make, with no proceeds in hand to pay it. And because liquidations happen when prices are falling, the rest of your portfolio is usually down at the same moment. It is the same uncomfortable shape as owing tax on crypto you never cashed out.

It can also cut the other way. If the liquidation happens below what you originally paid, you may have a capital loss rather than a gain, and that loss may be useful. Which outcome you get depends entirely on your cost basis, which is exactly the number most crypto holders are least sure about.

Three details that get overlooked

• The interest. Whether interest on the loan is deductible generally depends on what you used the borrowed money for, not on the fact that the loan was collateralised with crypto. Personal use and investment use are treated differently, and the rules are strict. Do not assume it is deductible.
• Wrapping the collateral. Some platforms require you to convert a coin into a wrapped or bridged version before posting it. That conversion can itself be a disposal, which means a taxable event can occur before the loan even begins.
• Who is holding your coins. Some lenders lend out or otherwise use collateral while your loan is outstanding. Others hold it untouched in custody. That difference matters, because the whole reason the loan is not a disposal is that you never gave up ownership.

If the loan is on-chain, add another layer

Decentralised lending introduces mechanics with no clean traditional analogue. Protocols that liquidate automatically, that issue you a receipt or derivative token in exchange for your deposit, or that repay your loan out of yield generated by your own collateral, can create income events sitting on top of the disposal question.

There is no single rule that resolves all of these. The analysis generally comes back to a few questions: did beneficial ownership actually change, was a materially different property or right created, what was the event worth in your home currency at the time, and what documentation supports the position you took.

What to do before you borrow

1. Know your cost basis first. It is what decides whether a liquidation is a gain or a loss, and it is not something you want to be reconstructing under pressure.
2. Treat your liquidation price as a tax number, not just a risk number. Work out what the tax consequence would be if it were hit, before you accept the loan.
3. Read the terms and keep them. Whether the lender can use your collateral, and whether you had to wrap it, both change the analysis.
4. Document your reasoning at the time. In an area this unsettled, a contemporaneous note explaining your position is worth far more than a reconstruction years later.

Borrowing against crypto to avoid a taxable sale is a legitimate strategy, and often a good one. It just is not the same as avoiding tax altogether. It defers the decision, and it hands the timing of that decision to the market. Which is fine, as long as you know that is the trade you are making.

Dilan Ropero

Head of Crypto Accounting and Senior Accountant at MyBookly Accounting. He works directly with digital asset investors on tax strategy, compliance, and reconstructing messy crypto histories.