That Bitcoin you bought in 2020 has grown nicely. The Ethereum you earned from staking is building up. But now tax season is approaching, and you're staring at a jumble of transactions across multiple wallets wondering: what exactly do I need to report to the IRS?
You're not alone. Cryptocurrency taxation remains one of the most confusing areas of tax compliance, made even more complex by significant rule changes that took effect in 2025. Let's cut through the confusion and break down exactly what you need to know.
The Fundamental Rule: Crypto Is Property, Not Currency
The IRS treats cryptocurrency as property, not currency. This classification, established in Notice 2014-21, means that virtually every crypto transaction triggers the same tax rules that apply to selling stocks or real estate.
Unlike exchanging dollars for euros, swapping Bitcoin for Ethereum is treated as selling one asset and purchasing another, potentially triggering capital gains or losses. Many crypto investors who treated their digital assets like currency have found themselves facing unexpected tax bills.
The Digital Asset Question: Everyone Must Answer
Starting with the 2022 tax year, the IRS added a mandatory question about digital assets near the top of Form 1040: "At any time during 2024, did you: (a) receive (as a reward, award, or payment for property or services); or (b) sell, exchange, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?"
Every taxpayer must check either "Yes" or "No"—leaving it blank is not an option.
Check "Yes" if you:
Sold crypto for dollars, traded one crypto for another (including stablecoins), used crypto to buy goods or services, received crypto as payment, earned mining or staking rewards, received airdrops or hard fork proceeds, or gifted cryptocurrency.
Check "No" if you only:
Held cryptocurrency without transacting, purchased crypto with dollars (without disposing of any), or transferred crypto between your own wallets.
The distinction is critical: buying crypto with dollars doesn't trigger a "Yes," but using crypto to buy a coffee does.
Understanding Taxable Events
Capital Gains and Losses
When you dispose of cryptocurrency, you have a capital gain or loss equal to the difference between what you received and your cost basis. If you held the crypto for more than one year, you'll pay long-term capital gains rates (0%, 15%, or 20% depending on income). Holdings of one year or less are taxed at your ordinary income rate.
Ordinary Income
Some crypto transactions generate ordinary income: receiving crypto as wages, mining rewards, staking rewards, and airdrops. The fair market value at the moment you receive it becomes both your taxable income and your cost basis for future sales.
Mining as a business:
If you mine cryptocurrency as more than a hobby, your rewards are subject to self-employment tax (15.3%) in addition to income tax. You'd report on Schedule C and can deduct business expenses like electricity and equipment. Hobby miners report on Schedule 1 without expense deductions.
Non-Taxable Events
These don't create immediate tax obligations: buying crypto with fiat currency, holding cryptocurrency, transferring between your own wallets, and receiving crypto as a gift. However, you still need to track these for basis purposes.
NFTs and the Collectibles Question
NFTs follow general crypto tax principles, but some may be taxed as "collectibles" with a higher 28% maximum rate (versus 20% for other long-term capital gains).
In Notice 2023-27, the IRS announced it will use a "look-through" approach: if the underlying asset the NFT represents would be a collectible (artwork, gems, antiques), then the NFT is too. An NFT certifying ownership of a gemstone is a collectible; an NFT representing virtual land generally isn't.
The IRS is still considering whether digital artwork qualifies as "works of art" under collectibles rules—a gray area NFT investors should watch.
How Basis Works
Your basis determines your gain or loss when you sell. Getting this right is crucial.
- Purchased crypto:
Your basis is what you paid, including transaction fees.
- Crypto received as income:
Basis equals the fair market value when received (the same amount you reported as income).
- Gifted crypto:
For gains, use the donor's basis. For losses, use the lower of donor's basis or fair market value at the time of the gift.
- Crypto-to-crypto trades:
You're treated as selling the first crypto. Your basis in the new crypto equals its fair market value at the time of exchange.
The 2025 Change: Wallet-by-Wallet Tracking
Prior to 2025, you could treat all holdings of a cryptocurrency as one pool regardless of which wallet held them. Starting in 2025, you must use "wallet-by-wallet" tracking—sales must be matched with basis from purchases made on that same platform.
The IRS provided transitional guidance in Revenue Procedure 2024-28 for allocating existing basis to specific wallets. If you didn't address this before January 1, 2025, you may face compliance challenges.
Reconstructing Missing Basis
If you can't prove your basis, the IRS may treat it as zero—making your entire proceeds taxable. To reconstruct records: contact exchanges for historical data, check email for purchase confirmations, review bank statements for exchange payments, and use blockchain explorers with historical price data.
Document your reconstruction efforts thoroughly. Courts have sometimes accepted reasonable estimates when taxpayers demonstrate good-faith attempts to determine actual basis.
Cost Basis Methods
Within each wallet, you can choose which units to sell:
- FIFO (First In, First Out):
Earliest units sold first—the default method
- LIFO (Last In, First Out):
Most recent units sold first
- HIFO (Highest In, First Out):
Highest-basis units sold first, minimizing gains
- Specific Identification:
You designate exact units at time of sale
You can only change methods prospectively. Work with a tax professional before switching.
Foreign Exchange Reporting
If you hold crypto on foreign exchanges, you may have additional reporting obligations with severe penalties.
FBAR (FinCEN Form 114)
The FBAR requires reporting foreign financial accounts if aggregate value exceeds $10,000 at any time during the year. While FinCEN hasn't finalized crypto-specific rules, it announced in 2020 that digital assets will be included. Many professionals recommend voluntarily reporting foreign crypto exchange accounts now.
Foreign exchanges triggering potential FBAR considerations include Binance.com (not Binance.US), KuCoin, and Bitfinex. U.S.-based exchanges like Coinbase and Kraken don't require FBAR reporting.
The FBAR is due April 15 with automatic extension to October 15. Penalties reach $10,000 per violation for non-willful failures, and over $100,000 for willful violations.
Form 8938 (FATCA)
FATCA requires reporting specified foreign financial assets exceeding $50,000 on the last day of the year or $75,000 at any point (thresholds vary by filing status). The conservative approach is including foreign crypto holdings if you exceed thresholds.
Exchange Bankruptcies and Frozen Assets
The collapse of FTX, Celsius, and BlockFi left investors with complex tax questions.
Staking rewards on frozen platforms:
In CCA 202444009, the IRS ruled that if you had "dominion and control" over rewards when credited, they're taxable income—even if the account froze before you could withdraw. You may owe taxes on rewards you can never access.
Claiming losses:
You generally can't claim a loss while assets are frozen in ongoing bankruptcy. Once resolved, if you receive nothing, the loss may be treated as worthless investment property—which unfortunately isn't deductible for individuals through 2025. If you receive a partial distribution, that's a sale, and your loss equals basis minus what you received.
Document everything and download transaction histories before exchanges remove access.
What Forms Do You File?
- Form 8949 and Schedule D:
Capital gains and losses from selling or exchanging crypto held as a capital asset.
- Schedule 1:
Other income including mining, staking, and airdrops.
- Schedule C:
Mining as a business, crypto trading business, or self-employed contractor payments.
- Form 709:
Gifts exceeding annual exclusion amounts.
Form 1099-DA: The New Reporting Era
Starting with 2025 transactions, exchanges must issue Form 1099-DA reporting gross proceeds. For 2026 transactions, they'll also report cost basis for assets acquired after January 1, 2025.
The IRS will now have independent information about your crypto transactions. If your reported numbers don't match, expect questions.
What If You Haven't Reported in Prior Years?
With Form 1099-DA reporting now active, unreported crypto is increasingly likely to be discovered. Options include:
- Amended returns:
File Form 1040-X for prior years. You'll owe additional tax plus interest and potentially penalties, but you'll demonstrate good faith compliance.
- Voluntary disclosure:
For significant unreported income or potential criminal exposure, the IRS Voluntary Disclosure Program provides a path with reduced penalty risk.
The worst approach is doing nothing. Penalties for tax evasion are severe, and interest compounds daily.
Common Mistakes to Avoid
- Treating crypto-to-crypto trades as non-taxable.
Every swap is a taxable event, even without converting to dollars.
- Ignoring small transactions.
The IRS makes no exception for small amounts.
- Using exchange basis without verification.
Exchanges often lack complete information. You're responsible for accuracy regardless of what any 1099 says.
- Overlooking foreign reporting.
FBAR and Form 8938 penalties are severe and separate from income tax penalties.
Planning Opportunities
- Tax-loss harvesting:
Sell crypto at a loss to offset gains. Unlike stocks, crypto currently isn't subject to wash sale rules.
- Long-term holding:
Hold more than one year for lower capital gains rates.
- Charitable giving:
Donate appreciated crypto to deduct fair market value while avoiding capital gains.
- Lot selection:
Use HIFO or specific identification to minimize gains when appropriate.
Get Your Crypto Taxes Right
Cryptocurrency taxation isn't optional, and the IRS is paying closer attention than ever. The rules are complex, but manageable with proper tracking and professional guidance.
At Desert Rose Tax & Accounting, we help clients navigate cryptocurrency reporting, establish proper record-keeping systems, and develop strategies to minimize tax burden while staying fully compliant. Whether you have a few transactions or a complex portfolio across multiple wallets, we can help ensure you're meeting your obligations without paying more than necessary.
Contact us today to schedule a consultation and get your cryptocurrency taxes in order.
Edward Ethington, CPA, CFP®, MBA
Desert Rose Tax & Accounting
Your Partner in Digital Asset Tax Compliance
(520) 747-4964
www.desertrosetax.com
This blog provides general information about cryptocurrency taxation and should not be construed as personal tax advice. Cryptocurrency tax rules are complex and evolving. Please consult with a qualified tax professional at Desert Rose Tax & Accounting for guidance specific to your situation.
