These days, cryptocurrency has steadily moved from a niche interest to a mainstream investment and payment method. As its use has expanded, so too has government scrutiny—particularly from the Internal Revenue Service (IRS). For individuals and businesses alike, understanding how the IRS treats crypto is critical to staying compliant and avoiding unexpected tax consequences. Despite popular perception of cryptocurrencies like Bitcoin or Ethereum as digital alternatives to cash, the IRS treats crypto like property not currency. This distinction has profound implications for reporting income, capital gains, and even everyday transactions made with crypto. In this blog, we’ll unpack how the IRS views cryptocurrency, what that means for different types of transactions, and how individuals can ensure they’re meeting their tax obligations.

The IRS’s Classification of Cryptocurrency

To understand your responsibilities as a taxpayer, the most important thing to know is that the IRS treats crypto like property not currency. This classification was first clarified in 2014, when the IRS issued Notice 2014-21. In it, the agency declared that for federal tax purposes, virtual currencies are treated as property. That means they are subject to the same tax principles that apply to other forms of property, such as stocks or real estate.

This treatment contrasts with how fiat currencies like the U.S. dollar are handled. If you exchange U.S. dollars for euros, for example, the IRS doesn’t require you to track gains or losses unless you’re trading in very large amounts. But with crypto, every single transaction—even small ones—must be recorded, and any gains or losses reported. This includes exchanging one cryptocurrency for another, using crypto to buy goods and services, and selling crypto for fiat currency.

For taxpayers, this introduces a layer of complexity. They must determine the fair market value of the crypto at the time of the transaction and compare it with its basis (typically the purchase price) to calculate any gain or loss. This requirement places a considerable burden on those who frequently use crypto for transactions.

Selling Crypto and Realizing Capital Gains

When it comes to selling crypto for fiat currency, the IRS sees this as a taxable event. For example, if you purchased Bitcoin for $5,000 and later sold it for $20,000, you must report the $15,000 gain as income. The nature of this gain—whether it is considered short-term or long-term—depends on how long you held the crypto before selling it. Assets held for more than one year qualify for long-term capital gains rates, which are generally lower than ordinary income tax rates. Those held for one year or less are subject to short-term capital gains tax, which is taxed at the same rate as your regular income.

This structure has encouraged some investors to adopt long-term holding strategies, often referred to as “HODLing” in crypto communities. The potential for favorable long-term capital gains rates can be a compelling incentive. However, this strategy also demands detailed record-keeping. Taxpayers must keep accurate records of purchase dates, prices, and sales to calculate the appropriate gains or losses correctly.

Losses from selling crypto can also be used to offset other capital gains, and if your losses exceed your gains, you may be able to deduct up to $3,000 per year from your ordinary income, with the remaining losses carried forward to future years.

Using Crypto for Purchases: A Hidden Tax Trap

One area that often surprises new crypto users is how the IRS treats using crypto to buy goods and services. While it might feel like you’re simply spending money, the IRS considers this a two-part transaction. First, you are “selling” your cryptocurrency (a taxable event), and second, you are purchasing a product or service. That means you need to calculate any gain or loss based on the value of the crypto when you originally acquired it versus its value at the time of the purchase.

Let’s say you bought 1 Ethereum at $1,000 and later used it to buy a laptop when Ethereum was valued at $3,000. You must report a $2,000 capital gain, even though you didn’t technically “sell” your Ethereum in the traditional sense. This rule applies even for small purchases like a cup of coffee or a sandwich, making tax reporting especially cumbersome for those who frequently use crypto in daily life.

This requirement has been criticized for discouraging the use of cryptocurrency as a medium of exchange, one of its original intended purposes. Many argue that the complexity of tracking and reporting taxes on everyday transactions undermines the practicality of using crypto like cash. Nonetheless, until new legislation is introduced, this is the current rulebook.

Crypto Mining, Staking, and Airdrops: Income Tax Implications

Beyond buying, selling, or spending crypto, there are other ways to acquire digital assets that also come with tax responsibilities. Crypto earned through mining, staking, or airdrops is considered taxable income. The IRS treats this type of income as ordinary income based on the fair market value of the coins at the time they are received.

For instance, if you mine a block of Bitcoin and receive a reward valued at $10,000, that $10,000 must be reported as income. Later, if you sell the Bitcoin for more or less than $10,000, you must also report the gain or loss from that transaction. This creates a dual reporting requirement: once for the income received and again for the capital gain or loss when the asset is disposed of.

Taxpayers who engage in these activities frequently may also be considered self-employed, requiring them to pay self-employment taxes in addition to income taxes. If this is the case, it becomes crucial to maintain thorough documentation and potentially seek guidance from a tax professional to ensure all obligations are met.

Reporting Requirements and the Risk of Non-Compliance

To ensure compliance, the IRS has ramped up enforcement efforts in recent years. Tax forms now include specific questions about cryptocurrency activity, prominently placed on Form 1040. The question asks if you received, sold, exchanged, or otherwise disposed of any financial interest in any virtual currency. This places a legal obligation on taxpayers to disclose their involvement with crypto, and a failure to do so could be considered perjury or lead to penalties if discovered during an audit.

Additionally, cryptocurrency exchanges may issue Form 1099 to users and report transactions to the IRS, particularly if they meet certain thresholds. However, not all exchanges provide these forms, and many operate internationally, which can further complicate compliance for users who assume that crypto activity is private or anonymous.

While some may be tempted to avoid reporting smaller crypto transactions, this is a risky strategy. The IRS has publicly stated that it is increasing its focus on virtual currency enforcement, and it has used tools like data analytics and subpoenas to track down unreported income. In some cases, the agency has even collaborated with blockchain analysis firms to identify users behind wallet addresses.

To stay compliant, it’s essential to keep detailed records of every crypto transaction, including the date, fair market value, and purpose. Software tools exist to help automate this process, but it still requires vigilance. Hiring a tax advisor familiar with crypto may also be a prudent move for frequent traders or those with complex holdings.

Looking Forward: Legislative and Regulatory Trends

The tax landscape for cryptocurrency is still in flux. Lawmakers have introduced several proposals aimed at simplifying crypto tax reporting. One such proposal would create a de minimis exemption for small transactions—potentially exempting gains on crypto purchases under a certain dollar threshold from taxation. This could significantly ease the burden on individuals using crypto for everyday spending.

Another area of focus is information reporting. The Infrastructure Investment and Jobs Act of 2021 included provisions requiring brokers—defined broadly to include certain cryptocurrency exchanges and wallet providers—to report user activity to the IRS. These requirements, expected to go into effect in the coming years, may help the IRS better track crypto activity, but they also raise concerns about privacy and regulatory overreach.

As the regulatory framework continues to evolve, taxpayers and industry participants should stay informed and proactive. The IRS’s guidance is likely to expand, and with it, the tools used to enforce compliance. Those who understand the current rules and prepare for future changes will be best positioned to navigate this complex landscape.

Conclusion

Cryptocurrency has introduced a new era of financial innovation, but it also comes with new responsibilities. The IRS treats crypto like property not currency, creating a tax framework that demands accurate record-keeping, diligent reporting, and an awareness of how even routine transactions—like using crypto to buy goods and services or selling crypto for fiat currency—can have significant tax consequences. As enforcement efforts increase and regulations continue to evolve, staying compliant requires more than just an interest in digital assets—it requires a firm grasp of the tax code and a commitment to transparency. Whether you’re a casual investor or a dedicated crypto enthusiast, understanding how the IRS sees your digital currency is essential to managing your financial future.