What Are Smart Contract Approvals?
An approval is a permission you grant a smart contract to handle your tokens. For example, when you connect your wallet to a decentralized exchange (DEX), you often need to approve the contract to move your tokens on your behalf. This approval is a transaction that sets a limit on how many tokens the contract can transfer.
This step is crucial because it authorizes future calls—like swapping or staking—to occur. However, the approval itself is a separate blockchain transaction, often overlooked in tax calculations. It’s similar to giving a valet your car keys—it’s permission, not a sale.
[Diagram suggestion: Wallet approval process flow, showing user, approval transaction, and subsequent call]
How Contract Calls and Transactions Work
Once approved, you make a call to the smart contract to execute an action. For example, swapping tokens, adding liquidity, or staking. These calls are transactions that can involve multiple steps and costs.
Each call consumes gas—paid in ETH—which compensates miners for processing your request. The call’s result can be successful or fail. A successful call results in token swaps, deposits, or other changes. A failed call, however, can still incur gas costs without any change to your assets.
[Diagram suggestion: Transaction flow from wallet to smart contract, including approval, call, and gas payment]
Gas Fees as a Cost Basis
Gas fees are paid upfront in ETH and represent a cost of executing transactions. For tax purposes, the IRS treats gas as a transaction cost—similar to a broker fee or commission.
If you make a trade, your cost basis includes the amount paid in gas. For example, if you swap 1 ETH and pay $20 in gas, your total cost basis for that ETH is $2,020. When you sell or dispose of that ETH later, the gas paid is added to your acquisition cost.
Note that gas paid for failed transactions still counts as a cost. Even if a trade doesn’t go through, the gas expense is real and should be tracked.
[Example: You attempt to swap tokens, pay $15 in gas, but the transaction fails. You should record the $15 as a transaction cost, even though no assets changed hands.]
What About Failed Transactions?
Failed transactions happen when the network rejects your call—due to slippage, insufficient gas, or other errors. Despite no asset transfer, you still pay gas, which is a real expense.
The IRS considers transaction costs as part of your basis or as deductible expenses in some cases. Currently, the guidance is unclear, but most experts agree: track all gas paid, including for failed transactions.
Failing to record these costs can lead to underestimating your cost basis or overpaying taxes. For example, if you paid $10 in gas for a failed swap, that $10 should be included in your cost basis or deducted as an expense.
[Example: You try to unstake tokens, but the transaction fails. You paid $8 in gas—record this to avoid inaccurate gain calculations.]