Overview

Cryptocurrency gains are taxable and increasingly scrutinized by the IRS. The agency treats virtual currency as property, not currency, which means transactions can create capital gains or losses. Accurate tracking and clear reporting reduce audit risk and help you claim legitimate losses and exemptions.

This article explains how gains are calculated, which events are taxable, what forms to use, common audit triggers, and practical steps to prepare for or respond to an audit. It reflects current IRS guidance (see IRS Cryptocurrency) and professional practice as of 2025. This is educational material and not individualized tax advice—consult a licensed tax professional for personal issues.

Why the IRS treats crypto as property

In 2014 the IRS issued Notice 2014-21 explaining that virtual currencies are treated as property for federal tax purposes. That classification means general tax principles that apply to property transactions—like stocks or real estate—also apply to crypto. The IRS continues to expand guidance and enforcement on this issue; see the IRS cryptocurrency page for updates (IRS, Cryptocurrency: https://www.irs.gov/cryptocurrency).

Taxable events: when a gain or loss occurs

Not every crypto movement is taxable, but many are. Common taxable events:

  • Selling cryptocurrency for fiat currency (e.g., USD).
  • Trading one cryptocurrency for another (e.g., BTC for ETH).
  • Using cryptocurrency to pay for goods or services.
  • Receiving cryptocurrency as compensation for services or from mining (taxed as ordinary income at receipt).
  • Receiving tokens from certain airdrops or hard forks, depending on facts and IRS guidance.

Non-taxable events include moving coins between wallets you own (if the cost basis and ownership don’t change) and long-term holding with no sale/exchange.

How to calculate gain or loss (cost basis and holding period)

A gain or loss equals the amount realized minus your adjusted basis.

  • Amount realized: fair market value (in USD) of what you receive at the transaction time.
  • Adjusted basis: what you paid for the crypto, including fees. If acquired in multiple lots, you must determine which lot’s basis applies.

Methods to determine basis include:

  • FIFO (first-in, first-out): default for many taxpayers if specific identification isn’t used.
  • Specific identification: identifying particular units sold (requires reliable records).
  • Average cost is not allowed for crypto like it can be for mutual funds.

Holding period matters: short-term gains (one year or less) are taxed as ordinary income rates; long-term gains (more than one year) qualify for lower capital gains rates.

Reporting: forms and where to include gains

  • Form 8949, Sales and Other Dispositions of Capital Assets: report each taxable sale/exchange of cryptocurrency, including date acquired, date sold, proceeds, cost basis, and gain/loss. (See Form 8949 on IRS.gov.)
  • Schedule D (Form 1040): summarizes totals from Form 8949 and computes net capital gain or loss.
  • Form 1040, Schedule 1 or Schedule C: report ordinary income from crypto mining, staking, or business activity. If you received crypto as payment for goods/services, include its fair market value in income.
  • Miscellaneous 1099 forms: brokerages or exchanges may issue 1099-B, 1099-K, or 1099-NEC—these are informational; the IRS may receive copies, which can trigger automated matching.

Practical note: Even if you do not receive a 1099, you are still responsible for reporting taxable events.

Audit triggers specific to cryptocurrency

The IRS has increased data matching and targeted outreach related to virtual currency. Common red flags that prompt audits or notices:

  • Discrepancies between IRS-provided 1099s and reported income.
  • Failure to report proceeds that appear on exchange records or third-party reports.
  • Large, frequent trades without clear records of basis or transfers among wallets.
  • Claiming losses or wash-sale–like positions (note: wash sale rules currently apply to stocks; as of 2025, they do not explicitly apply to crypto under IRS rules, though legislative or regulatory changes can affect this). Always consult a tax pro about recent rule changes.
  • Receiving crypto as income but not reporting the fair market value on the receipt date.

If the IRS suspects underreporting, it may issue a CP2000 notice (proposed changes), a notice of deficiency, or open a field audit.

What happens during a crypto-related audit

  • Document request: the IRS will ask for transaction histories, wallet addresses, exchange statements, and cost-basis calculations.
  • Verification: the auditor will match the taxpayer’s returns to third-party reports (1099s, blockchain records, and exchange data).
  • Adjustments and penalties: if underreporting is found, the IRS can assess additional tax, interest, and penalties. Penalty relief is sometimes available for reasonable cause and timely correction.

If you get a notice, respond promptly and provide organized records. If you disagree with the audit result, you can appeal administratively and, if necessary, litigate.

Recordkeeping best practices (to prevent audits)

  • Export CSVs and PDF statements from every exchange and wallet you use.
  • Keep records of purchase date, purchase price in USD, transaction fees, transfer dates, and wallet addresses.
  • Use a crypto tax or portfolio tracker that supports lot-level identification and produces Form 8949 outputs.
  • Reconcile exchange reports to your records annually.

For detailed practical guidance on organizing records see our article: Cryptocurrency Recordkeeping Best Practices for Tax Reporting.

Cost-basis nuances and methods

  • Fees and transaction costs: add exchange fees and certain transaction costs to basis. Gas fees on transfers may be treated differently depending on facts—document them.
  • Forks and airdrops: the tax consequences depend on whether you have dominion and control over the new tokens. See the IRS FAQs and our guide: How to Report Cryptocurrency Forks and Airdrops on Your Tax Return.
  • Transfers between wallets: moving crypto between wallets you control is generally not a taxable event, but you must maintain records to show continuity and basis.

Software tools and professional help

Automated crypto tax software (e.g., CoinTracker, TaxBit, Koinly) can import exchange history and generate reports and draft Form 8949 lines. In my experience as a tax practitioner, these tools speed reconciliation but do not replace thorough review—especially when trades are numerous, or there are forks, airdrops, staking, or cross-chain swaps.

Engaging a CPA or tax attorney experienced in crypto is worthwhile when:

  • You have high-volume trading.
  • You run a mining or staking operation.
  • You received complex token distributions.
  • You’re facing an audit or need to amend returns.

Real-world examples

Example 1: Sale for fiat

  • Buy 1 BTC for $10,000 in 2020. Sell 1 BTC for $30,000 in 2024.
  • Gain = $20,000. Report on Form 8949 (gain qualifies for long-term capital gains if held >1 year) and carry totals to Schedule D.

Example 2: Trade crypto for crypto

  • Trade 2 ETH (basis $2,000 each) for LTC worth $6,000 total.
  • Recognize gain based on fair market value of LTC received versus basis of ETH disposed.

Example 3: Mining income

  • Receive 0.5 BTC from mining when FMV at receipt is $15,000.
  • Report $15,000 as ordinary income at receipt; later sale creates separate capital gain or loss.

Amending returns and voluntary disclosure

If you discover unreported crypto income or gains, file an amended return (Form 1040-X) to correct prior-year filings. The IRS has pursued enforcement campaigns; voluntary correction often yields lower penalties than discovery through an audit.

See our guide: How to Amend a Tax Return for Unreported Cryptocurrency Transactions.

Practical tips to reduce audit risk

  • Keep consistent, verifiable records and back them up off-site.
  • Use specific identification when possible to optimize tax outcomes.
  • Report income and gains fully even if you don’t receive 1099s.
  • Work with a tax professional familiar with crypto.

FAQs (brief)

  • Q: Do I need to report small crypto sales? A: Yes—every taxable event should be reported; the IRS expects full reporting regardless of size.
  • Q: Will the IRS see my wallet on the blockchain? A: The blockchain is public but not directly tied to your identity. Exchanges and payment processors provide information that the IRS can match to taxpayers. The IRS has also contracted with analytics firms to trace transactions.

Sources and further reading

Professional disclaimer

This article is educational and reflects tax guidance and common practice as of 2025. It does not constitute personalized tax, legal, or investment advice. Consult a qualified tax professional for advice tailored to your specific facts and to confirm whether recent legislative changes affect your situation.