Cryptocurrency has become a major part of the modern investment landscape, with millions of Americans trading, holding, and spending digital assets like Bitcoin, Ethereum, and thousands of altcoins. But as crypto adoption grows, so does IRS scrutiny. Many taxpayers are still unaware that the IRS considers cryptocurrency to be property—and therefore subject to capital gains tax rules. Understanding how the IRS tracks cryptocurrency gains and losses is crucial to remaining compliant and avoiding potential penalties.
Cryptocurrency and IRS Classification
The IRS officially classifies cryptocurrency as property, not currency, under IRS Notice 2014-21. This means crypto transactions are treated similarly to the sale of stocks or real estate. Every time you sell, trade, or otherwise dispose of cryptocurrency, it creates a taxable event that must be reported on your tax return.
Examples of taxable crypto events include:
- Selling crypto for fiat currency (e.g., USD)
- Trading one cryptocurrency for another
- Using crypto to buy goods or services
- Receiving crypto through mining, staking, or as payment
How the IRS Gets Crypto Data
The IRS has several methods for obtaining cryptocurrency transaction data. These include:
1. Exchange Reporting (Form 1099)
Cryptocurrency exchanges like Coinbase, Kraken, and Binance.US are required to report certain transactions to the IRS. Beginning in 2023 and increasingly into 2025, exchanges must issue Form 1099-DA (Digital Asset) to both the IRS and users.
This form includes:
- Gross proceeds from crypto sales
- Dates of sale and acquisition
- Type of digital asset sold
- Wallet addresses associated with the user
2. Third-Party Data Matching
The IRS uses sophisticated software tools and partnerships with third-party blockchain analytics firms like Chainalysis to track wallet movements and link addresses to known exchanges or users.
3. John Doe Summons
The IRS can issue a “John Doe” summons to crypto exchanges to obtain user records for customers who may not have been identified individually but are suspected of non-compliance. This was previously done with Coinbase in 2017 and other platforms in subsequent years.
4. Taxpayer Self-Reporting
The IRS includes a direct question on Form 1040: “At any time during the year, did you receive, sell, exchange, or otherwise dispose of any financial interest in any virtual currency?” Answering this question untruthfully can lead to serious legal consequences.
Tracking Gains and Losses
Cryptocurrency gains and losses are calculated using capital gains principles. Each crypto sale must be tracked for:
- Date acquired (purchase date)
- Date sold or exchanged
- Cost basis: Original purchase price (including fees)
- Gain or loss: Difference between proceeds and cost basis
Capital gains are categorized as:
- Short-term: Held for one year or less (taxed as ordinary income)
- Long-term: Held for more than one year (taxed at favorable rates)
Form 8949 and Schedule D
Crypto gains and losses must be reported on:
- Form 8949: Lists each individual crypto transaction, including date acquired, date sold, cost basis, sale proceeds, and gain/loss.
- Schedule D (Form 1040): Summarizes the total capital gains and losses from Form 8949 and combines them with other capital transactions.
If you have more than a few crypto transactions, you may need specialized crypto tax software to generate these forms accurately (e.g., CoinTracker, Koinly, or TokenTax).
Dealing with Crypto Losses
Crypto losses can reduce your tax liability. Here’s how:
- Offset gains: Use losses to cancel out taxable gains from crypto or other investments.
- Annual deduction: Deduct up to $3,000 of net capital losses per year against ordinary income ($1,500 if married filing separately).
- Carryforward: Unused losses can be carried forward indefinitely to offset future gains.
Keep careful records of all your losses. Even losses from rug pulls or scams may be eligible for deduction under certain IRS rules, but they must be well-documented and may require a theft loss claim or worthless asset treatment.
Mining, Staking, and Crypto Income
Crypto obtained through mining, staking, or as income (such as freelancing paid in crypto) is treated as ordinary income. The fair market value of the coins on the date received is included in your income for that year and taxed accordingly.
Later, if you sell or convert those same coins, a capital gain or loss is calculated based on the difference between the fair market value on the receipt date (your cost basis) and the value at the time of disposal.
IRS Enforcement and Penalties
The IRS has significantly stepped up enforcement on crypto-related noncompliance. Failing to report crypto income or gains can result in:
- Late payment penalties and interest
- Accuracy-related penalties (20% of the tax owed)
- Civil fraud penalties (up to 75% of underpayment)
- Criminal prosecution for willful tax evasion
The IRS has already sent out waves of warning and enforcement letters to crypto holders and is expanding its investigative capacity through its Office of Cyber Crime and IRS Criminal Investigation (CI) unit.
Best Practices for Crypto Tax Compliance
To stay compliant and avoid issues with the IRS, consider the following best practices:
- Track all transactions: Maintain accurate records of every buy, sell, exchange, and transfer. Include dates, amounts, and wallet addresses.
- Use crypto tax software: These tools automate gain/loss calculation and generate IRS-ready forms.
- Report honestly: Always answer the crypto question on Form 1040 truthfully, even if you only held or received crypto.
- Separate business and personal wallets: If you’re mining or earning income from crypto, use dedicated wallets for clarity.
- Consult a tax professional: Especially if you’ve engaged in complex transactions like DeFi, NFT trading, or international crypto exchanges.
NFTs, DeFi, and the Expanding Crypto Tax Landscape
The IRS is expanding its focus beyond basic crypto trades. New areas of enforcement include:
- NFTs: Treated as property; sales or exchanges of NFTs can trigger gains or losses.
- DeFi platforms: Yield farming, liquidity mining, and token swaps can generate income and capital gains.
- Wrapped tokens and bridges: Swapping tokens across blockchains may be considered taxable exchanges.
These transactions are often complex and lack 1099 reporting, placing the burden of compliance squarely on the taxpayer.
Conclusion: Stay Proactive, Stay Compliant
As cryptocurrency continues to evolve, so does IRS enforcement. The IRS has the tools, data partnerships, and regulatory authority to track cryptocurrency activity more closely than ever before. Self-reporting, accurate recordkeeping, and professional tax guidance are crucial to avoiding penalties and audits.
If you’ve traded, sold, earned, or even held crypto in 2025, it’s essential to understand how those actions impact your taxes. By staying informed and proactive, you can comply with IRS rules, leverage legal deductions, and minimize your risk while participating in the digital asset economy.
