Cryptocurrency and virtual currencies are subject to specific tax rules enforced by the IRS that differ significantly from traditional currency taxation. Since 2014, the IRS has classified cryptocurrencies like Bitcoin and Ethereum as property rather than currency IRS Notice 2014-21. This classification means that transactions involving crypto—whether selling, trading, spending, or mining—trigger capital gains and income tax rules similar to those used for stocks and other assets.
When you sell or exchange cryptocurrency, you must calculate your capital gain or loss by comparing the selling price (fair market value) to your original purchase price (cost basis). For example, trading Bitcoin for Ethereum is a taxable event where gains or losses must be reported. Similarly, when you use cryptocurrency to pay for goods or services, you must determine and report any gain or loss on the crypto spent.
Income is taxable when received as payment, mined as a reward, or obtained from forks and airdrops. Cryptocurrency received as salary is taxed at its fair market value at the time of receipt and may be subject to self-employment tax if earned through services. Mining rewards are considered ordinary income equal to the fair market value upon receipt, and new coins received from hard forks or airdrops are generally taxable income.
Both individual taxpayers and businesses must report all cryptocurrency income and capital gains or losses. Even small transactions require documentation to avoid IRS penalties or audits. Maintaining thorough records of dates, amounts, cost basis, and market values can simplify accurate tax reporting.
To manage this complexity, taxpayers often use specialized cryptocurrency tax software, which automates tracking transactions and preparing IRS forms such as Form 8949, which is used to report sales and dispositions of capital assets including cryptocurrencies. Proper use of such tools and consulting a tax professional can ensure compliance and optimize your tax position.
Common mistakes taxpayers make include believing cryptocurrency transactions are tax-free, failing to report small gains or income, neglecting to track cost basis, or treating crypto like traditional currency rather than property. These misunderstandings can lead to costly errors and IRS enforcement actions.
For detailed guidance, IRS Notice 2014-21 and the IRS Virtual Currency FAQs provide authoritative explanations. FinHelp’s glossary entries on cryptocurrencies and related tax forms can also help you understand tax obligations clearly. Knowing how the IRS treats cryptocurrency will help you file returns correctly and avoid surprises at tax time.
For more on reporting cryptocurrency transactions, see FinHelps related guides on Cryptocurrency Taxes and Form 8949 14; Sales and Other Dispositions of Capital Assets (critical for crypto transactions).
Recommended authoritative resource: IRS Virtual Currency FAQ https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions