Reporting Cryptocurrency on Your Tax Return: Responding to IRS Notices

Quick overview

Cryptocurrency is treated as property for U.S. federal tax purposes, so most dispositions (sales, trades, spending, or exchanging crypto-for-crypto) create taxable events that must be reported. If the IRS sends a notice claiming unreported cryptocurrency activity, respond promptly with clear records and corrected filings when needed.

(For the IRS guidance on virtual currency, see the IRS Virtual Currency FAQ and Cryptocurrency Tax Center.)

Why this matters now

Noncompliance can lead to extra tax, interest, and penalties. Since 2014 the IRS has classified virtual currency as property (IRS Notice 2014‑21), and enforcement has intensified as third‑party data reporting from exchanges improved. If you received a notice—commonly a CP2000 (proposed changes to income) or an examination letter—quick, accurate action usually limits further enforcement.

Sources: IRS Virtual Currency Guidance and FAQs (irs.gov) and the IRS Cryptocurrency Tax Center (irs.gov/cryptocurrency).

Practical steps to report cryptocurrency correctly

1. Identify taxable events

• Sales for USD, trades (crypto → crypto), spending crypto to buy goods or services, and receiving crypto as payment or mining income are taxable events. (IRS Notice 2014‑21)
• Buying crypto with USD is not a taxable event by itself.

1. Determine cost basis and holding period

• Cost basis is generally what you paid for the asset (including fees). If acquired by receipt (payment, mining), the basis is the fair market value in USD at the time you received it.
• Holding period determines short‑term (taxed at ordinary rates) vs. long‑term gains (preferential rates).

1. Convert values to USD

• Use the fair market USD value at each transaction’s date. Use a consistent, documented source of exchange rates and note the time zone when applicable.

1. Use the right tax forms

• Report capital transactions on Form 8949 with totals carried to Schedule D (Form 1040). Report ordinary income from mining, staking, or payment for services as wages or other income on Form 1040 (and self‑employment forms if applicable). See IRS Form 8949 instructions.

1. Retain documentation

• Keep exchange CSVs, wallet export files, receipts, invoices, and screenshots showing time stamps and USD values. Reconcile exchange data to your own records.

1. Use crypto tax software or a pro

• Reputable software can import exchange CSVs and calculate gains using FIFO, LIFO, or specific identification if supported. If you’re uncertain, consult a CPA or tax attorney with cryptocurrency experience.

Internal resources you may find useful: Cryptocurrency Recordkeeping Best Practices for Tax Reporting and Cryptocurrency Tax Reporting: Forms, Records, and Common Mistakes.

How to respond if you get an IRS notice about cryptocurrency

1. Read the notice carefully and note deadlines

• The notice will state the issue (underreported income, missing information, or proposed adjustments) and include a response deadline—don’t ignore it.

1. Compare the IRS data to your records

• Match the transactions cited to your exchange statements, wallet exports, and spreadsheets. The IRS often receives 1099‑B or 1099‑K style reports from exchanges or aggregated third‑party data that may differ from your calculated basis.

1. Prepare documentation to support your position

• Provide copies of exchange transaction histories, cost‑basis calculations, receipts, and a transaction log that shows dates, USD values, and how you computed gains or losses.

1. If the IRS is correct, agree and fix the error

• Pay the additional tax plus interest, or file an amended return (Form 1040‑X) if required. See our guide: How to Amend a Tax Return for Unreported Cryptocurrency Transactions.

1. If you disagree, explain and document

• Send a clear written explanation with supporting evidence. If the notice includes a proposed change (CP2000), follow the instructions to indicate disagreement and attach documents.

1. Request reasonable‑cause relief if warranted

• If you have a defensible reason for the mistake (lost records, theft of account access, or reliance on bad data), ask for penalty abatement and attach a concise explanation.

1. Escalate if necessary

• If you can’t resolve the issue in correspondence, you can request an audit reconsideration, appeal, or consult a tax attorney. Keep in mind the timeframes to appeal or file a petition in Tax Court.

Authoritative reference: IRS CP2000 information and Form 8949 instructions (irs.gov/forms-pubs/about-form-8949).

Common notice types related to crypto

• CP2000 — Proposed changes to income based on information returns. Often the first notice for mismatches.
• CP11/104C — Notices showing a balance due after calculation of tax matters.
• Examination letter — When the IRS opens an audit; requires documentation.

Respond to each type per the directions in the notice and keep a copy of everything you send.

Example response outline (what to include in a reply)

• Cover letter: brief description of your position and contact information.
• Transaction summary: a one‑page reconciliation tying IRS‑reported items to your records.
• Supporting documents: exchange CSVs, wallet histories, invoices, receipts, and screenshots showing timestamps and USD values.
• Computation worksheet: Form 8949 schedules or spreadsheet showing each trade’s cost basis, proceeds, gain/loss, and holding period.
• Request or statement: acceptance of change, request to correct, or request for penalty abatement.

In my practice I’ve found that a short, well‑organized packet (cover letter + reconciliation + key supporting documents) resolves most CP2000 issues without further examination.

When to amend your return vs. wait for IRS notice

• Amend immediately (Form 1040‑X) if you discover material unreported income or calculation errors before the IRS contacts you. This minimizes penalties and interest.
• If you receive a notice that’s incorrect and you agree with the IRS after review, follow the notice instructions—an amended return may still be appropriate.

See our in‑depth how‑to: How to Amend a Tax Return for Unreported Cryptocurrency Transactions.

Penalties, interest, and relief options

• Interest accrues on unpaid tax from the original due date.
• Penalties may include failure‑to‑pay and accuracy‑related penalties.
• Possible relief: first‑time penalty abatement (for certain failure‑to‑file/failure‑to‑pay penalties), reasonable‑cause penalty relief, or an installment agreement.
• If noncompliance was willful, civil penalties or criminal referral are possible; consult a specialist promptly.

Practical recordkeeping checklist

• Exchange CSV exports and API reports (download monthly if possible).
• Wallet addresses and transaction IDs (TxIDs) for on‑chain transactions.
• Dates and USD values for receipt, sale, trade or use.
• Invoices for goods or services paid with crypto.
• Cost basis methodology documentation (FIFO, specific identification, etc.).

For detailed procedures, see our Cryptocurrency Recordkeeping Best Practices for Tax Reporting.

Tools and professional help

• Choose reputable crypto tax software that imports CSVs and supports the cost‑basis method you want to use. Keep raw exchange files for verification.
• If the notice involves large amounts, multiple exchanges, or complex tax issues (forks, airdrops, staking), hire a CPA or tax attorney with crypto experience.

In my practice, proactive recordkeeping and an early consultation with a specialist reduce stress and save money when notices arrive.

Final checklist when responding to a notice

• Read the notice and note the deadline.
• Reconcile IRS data against your records.
• Prepare a clear, one‑page reconciliation and attach supporting documents.
• File an amended return if you agree with the need to change reporting.
• If you disagree, respond in writing with evidence and a polite explanation.
• Consider penalty relief requests if mistakes were non‑willful.
• Keep copies of everything you send and track delivery.

Disclaimer

This article is educational and not individualized tax advice. Tax rules and IRS procedures change. For help with a specific IRS notice or complicated cryptocurrency situations, consult a licensed tax professional (CPA, EA, or tax attorney) familiar with virtual currency taxation.

Authoritative sources and further reading

• IRS: Frequently Asked Questions on Virtual Currency Transactions (https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions)
• IRS: Cryptocurrency Tax Center (https://www.irs.gov/cryptocurrency)
• IRS Notice 2014‑21 (virtual currency tax guidance)
• IRS: About Form 8949, Sales and Other Dispositions of Capital Assets (https://www.irs.gov/forms-pubs/about-form-8949)

Related FinHelp articles:

• Cryptocurrency Recordkeeping Best Practices for Tax Reporting: https://finhelp.io/glossary/cryptocurrency-recordkeeping-best-practices-for-tax-reporting/
• How to Amend a Tax Return for Unreported Cryptocurrency Transactions: https://finhelp.io/glossary/how-to-amend-a-tax-return-for-unreported-cryptocurrency-transactions/
• Cryptocurrency Tax Reporting: Forms, Records, and Common Mistakes: https://finhelp.io/glossary/cryptocurrency-tax-reporting-forms-records-and-common-mistakes/