Cryptocurrency Tax Basics: Reporting, Cost Basis and Common Pitfalls

Quick primer

Cryptocurrency is taxed as property by the IRS, which means transactions create capital gains or ordinary income depending on the event. The key tasks for any crypto holder are: identify taxable events, determine accurate cost basis for each lot, document receipts (airdrops, mining, staking), and report transactions on the correct tax forms (Form 8949, Schedule D, and various income forms). See the IRS guidance on virtual currencies for primary rules (IRS: Virtual Currencies).

Why cost basis matters

Cost basis is the original value you paid for a crypto asset, adjusted for acquisition costs (like transaction fees). When you later sell or trade that asset, your taxable gain or loss equals the difference between the proceeds and your cost basis. Precise basis tracking can change whether a gain is short-term (taxed at ordinary rates) or long-term (lower capital gains rates), and it affects how much tax you ultimately owe.

Common taxable events (and how they’re reported)

• Selling cryptocurrency for U.S. dollars or other fiat: report capital gain or loss (Form 8949 → Schedule D).
• Trading one crypto for another: taxable exchange of property; calculate gain or loss based on fair market value (FMV) of the token received at the time of the trade.
• Using crypto to buy goods or services: treated as a disposition—report gain or loss measured by FMV of goods received compared to your basis.
• Receiving crypto as payment, mining, staking rewards, or airdrops: ordinary income at FMV when received; may also create later capital gain/loss when sold.

For official details, refer to IRS Notice 2014-21 and the Virtual Currencies FAQs (IRS: Virtual Currencies).

How to calculate cost basis — practical methods

There are three common approaches you’ll encounter:

1. Specific identification (best when supported). Identify the exact lot you sold using time-stamped records — date acquired, purchase price, and quantity. Many exchanges and wallets allow lot selection; this method can minimize gains when used strategically.
2. First-In, First-Out (FIFO). Assume the earliest-acquired units are the ones sold. FIFO is easy to apply when specific ID isn’t possible.
3. Last-In, First-Out (LIFO) or other methods. Less common; availability depends on recordkeeping and platform support.

Notes and caveats:

• Average cost basis (allowed for mutual funds under brokerage rules) is not generally applicable to cryptocurrency unless your broker explicitly uses and documents it for specific crypto products. Most crypto traders should not rely on it.
• The IRS accepts specific identification when you can substantiate it with records. In my practice I always advise documenting lot selection contemporaneously and keeping CSV exports from exchanges as proof.

Treatment of fees and adjustments

• Purchase fees. Add transaction fees paid in USD or crypto to your cost basis.
• Selling fees. Subtract transaction fees from proceeds when calculating gain.
• When fees are paid in the same crypto being bought/sold, record the fee amount and its FMV in USD at that time — this clarifies basis and proceeds.

Income events: mining, staking, airdrops, employer pay

• Mining: Mined coins are ordinary income at FMV when received and may be self-employment income (Schedule C) if you operate as a business.
• Staking rewards: The IRS treats many staking rewards as ordinary income when received (report as income; subsequent sale is capital gain/loss). Keep current with guidance and platform reporting.
• Airdrops & forks: Historically, certain airdrops are taxable as income when you have dominion and control. The IRS FAQs discuss these scenarios — check the Virtual Currencies FAQs for examples.
• Employer compensation: If you are paid in crypto, report wages and withhold payroll taxes as with cash compensation.

Filing and forms

• Form 8949 (Sales and Other Dispositions of Capital Assets): Use to list individual crypto sales/trades with dates, proceeds, cost basis, and gain/loss.
• Schedule D (Form 1040): Totals capital gains and losses from Form 8949.
• 1099-B / 1099-K / 1099-MISC / 1099-NEC: Crypto platforms may issue these; do not rely solely on third-party forms — reconcile to your records.
• Schedule 1 or Schedule C: Report ordinary income from mining, airdrops, or business activity. Self-employment tax applies to business mining or running validator nodes.

See also our guide on how crypto transactions map to tax forms: How Cryptocurrency Transactions Are Reported on Tax Forms.

Practical recordkeeping system (step-by-step)

1. Download CSVs and trade history from every exchange and wallet for each tax year.
2. Keep original records for deposits, purchases, receipts of income (airdrops/staking), and wallet-to-wallet transfers.
3. Use a reputable crypto tax tool to normalize exchange formats and perform lot-level matching.
4. Reconcile software results to exchange statements and bank records for deposits/withdrawals.
5. Save contemporaneous notes when you make a lot selection (specific ID) — screenshots or dated logs are acceptable evidence in an audit.

For more on recordkeeping best practices, see our related article: Cryptocurrency Recordkeeping Best Practices for Tax Reporting.

Real-world examples

• Example 1 (simple sale): You buy 1 BTC on 1/1/2020 for $7,000 and sell 1 BTC on 6/1/2023 for $30,000. Basis = $7,000; gain = $23,000 (long-term if held >1 year).
• Example 2 (trade crypto-to-crypto): You buy 10 ETH for $1,000 total. Later you trade 2 ETH for another token worth $500 at trade time. Basis for 2 ETH = ($1,000/10)*2 = $200; gain = $500 – $200 = $300.
• Example 3 (income + later sale): You receive 5 tokens in airdrop with FMV $50 each on receipt (ordinary income $250). Months later you sell that holding for $500, your basis for sale is $250, so capital gain = $250.

In my practice, clients who record income value at receipt and save exchange exports avoid costly reconstructions during audits.

Common pitfalls and how to avoid them

• Reliance on exchange 1099s without reconciliation: Platforms sometimes misreport or omit transactions. Reconcile all third-party forms to your own records.
• Mixing wallet transfers with taxable dispositions: Wallet-to-wallet transfers you control are not taxable but must be documented to avoid being treated as sales.
• Ignoring fees in basis or proceeds: Small fees add up and can materially change your gain/loss.
• Assuming wash sale rules apply: As of 2025, wash sale rules under IRC 1091 apply to “stocks and securities”; most crypto is treated as property, so wash sale rules generally do not apply. However, legislation could change this — consult your tax professional.
• Failing to treat staking and airdrops as income: Many taxpayers miss this step and later owe back taxes, interest, and penalties.

If you discover mistakes (amendments and audits)

• Amending returns: If you missed reporting crypto gains or income, file Form 1040-X to amend and include corrected Form 8949 and Schedule D. See our post on amending returns for crypto issues for process details.
• Audit preparedness: Keep trade histories, wallet records, and contemporaneous proof of lot selection. The IRS increasingly requests raw exchange exports in examinations.

Tools and professionals

• Crypto tax software can automate lot matching and produce Form 8949 exports — pick a vendor that supports the exchanges and wallets you used.
• Work with a CPA or tax attorney experienced in cryptocurrency. In my practice, complex cases (mining farms, liquidity provision, cross-border flows) benefit from a specialist review.

Bottom line

Treat crypto like property: document when you acquire tokens, track the cost basis including fees, report income when you receive crypto, and report disposals on Form 8949 and Schedule D. Good records reduce tax, audit risk, and the time spent reconstructing history.

Disclaimer

This article is educational and does not constitute tax advice. Rules change and individual circumstances vary. Consult a qualified tax professional for specific guidance.

Authoritative sources

• IRS — Virtual Currencies: https://www.irs.gov/businesses/small-businesses-self-employed/virtual-currencies
• IRS Notice 2014-21 (virtual currency tax treatment)