With the staggering rise and fall of some cryptocurrencies such as Bitcoin and Ethereum, crypto traders may have serious tax questions on their minds. The Internal Revenue Service (IRS) is stepping up enforcement efforts, and even those who hold the currency — let alone trade it — need to make sure they don’t run afoul of the law. That might be easier to do than you think, given how the IRS treats cryptocurrency.
“It’s a really big enforcement area for the IRS right now,” says Brian R. Harris, tax attorney at Fogarty Mueller Harris, PLLC in Tampa. “They’re generating a lot of publicity in going after people who hold, trade or use cryptocurrency. Those people can be a target for audit or compliance verification.”
While one of the selling points of Bitcoin, for example, has been its anonymity (or at least semi-anonymity), authorities have been playing catch-up in recent years with some success.
“The IRS and FBI are getting better at tracking and tracing Bitcoin as part of criminal investigations,” says Harris. And they can freeze assets, if needed, he adds.
So it’s all the more reason for those who transact in popular cryptocurrencies to know the law and what taxes they might incur by their actions. The good news: The IRS generally treats cryptocurrencies similarly to how it treats other capital assets such as stocks and bonds. The bad news: That treatment makes it difficult to use cryptocurrency to buy goods and services.
Here are a number of key things you need to know about cryptocurrency taxes and how to stay on the right side of the law.
Topics covered on this page:
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You’ll be asked whether you received, sold or used cryptocurrency
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You don’t escape being taxed just because you didn’t get a 1099
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Just using crypto exposes you to potential tax liability
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Gains on crypto trading are treated like regular capital gains
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Crypto miners may be treated differently from others
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A gift of crypto is treated the same as other gifts
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Inherited cryptocurrency is treated like other inherited assets
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The wash-sale rule does not apply to cryptocurrency
8 important things to know about crypto taxes
1. You’ll be asked whether you received, sold or used cryptocurrency
Your tax return requires you to state whether you’ve made some types of transactions in cryptocurrency. In a clear place near the top, Form 1040 asks whether taxpayers received, sold, sent, exchanged, gifted or otherwise disposed of a digital asset at any time in the tax year.
So you’re on the hook to answer definitively whether you’ve transacted in cryptocurrency, putting you in a position to potentially lie to the IRS. If you don’t answer honestly, you could be in further legal jeopardy, and the IRS does not look kindly on liars and tax cheats.
Most U.S. crypto owners haven’t reported their activities to the IRS, according to a recent study by Divly, a company focused on easing the burden of crypto taxation. Only an estimated 1.62 percent of U.S. crypto owners reported their holdings to the IRS in 2022.
However, taxpayers who only purchased virtual currency with real currency are not obligated to answer “yes” to the question. The IRS has also said that those who merely hold digital assets or transfer them between their own crypto wallets may also answer “no” to the question.
However, the emergence of Bitcoin exchange-traded funds in January 2024 may shake things up a bit on future tax returns. Investors who sold one of these funds may be wondering if they should answer “yes” to the IRS question on their 2024 year return.
“I’d advise clients to err on the side of caution,” says Harris. “I would check yes on that.”
Answering yes won’t necessarily incur a tax liability, he explains. It’s the actual gain or loss on a sale that will determine whether you owe taxes.
2. You don’t escape being taxed just because you didn’t get a 1099
With a bank or brokerage, you (and the IRS) will typically get a Form 1099 reporting the income you’ve received during the year. That may not be the case with cryptocurrency exchanges, however.
“There is potentially more informational reporting that will occur in the future, and these exchanges will be disclosing more information about digital assets and cryptocurrency,” says Harris.
But the lack of a 1099 won’t let you escape any tax liability, and you’ll still have to report your gains and pay tax on them. Still, it’s not all bad news: If you had to take a capital loss, you can deduct that on your return and reduce your taxable income.
“This increased reporting may cause some issues for those who haven’t disclosed cryptocurrency transactions before,” says Harris. “It’s in people’s better interest to start reporting.”
Even if you’ve filed taxes years before and think you’ve escaped taxes on crypto gains, the IRS can still come back to you and request you to pay up.
3. Just using crypto exposes you to potential tax liability
You might think that if you only use – but not trade – cryptocurrency you’re not liable for taxes.
Not true!
Any time you exchange virtual currency for real currency, goods or services, you may create a tax liability. You’ll create a liability if the price you realize for your cryptocurrency – the value of the good or real currency you receive – is greater than your cost basis in the cryptocurrency. So if you get more value than you put into the cryptocurrency, you’ve got yourself a tax liability.
Of course, you could just as well have a tax loss, if the value of goods, services or real currency is below your cost basis in the cryptocurrency.
In either case, you’ll have to know your cost basis to make the calculation.
It’s important to note that this is not a transaction tax. It’s a capital gains tax – a tax on the realized change in value of the cryptocurrency. And like stock that you buy and hold, if you don’t exchange the cryptocurrency for something else, you haven’t realized a gain or loss.
4. Gains on crypto trading are treated like regular capital gains
So you’ve realized a gain on a profitable trade or purchase? The IRS generally treats gains on cryptocurrency the same way it treats any kind of capital gain.
That is, you’ll pay ordinary tax rates on short-term capital gains (up to 37 percent in 2023 and 2024, depending on your income) for assets held less than a year. But for assets held longer than a year, you’ll pay long-term capital gains tax, likely at a lower rate (0, 15 and 20 percent).
And the same rules for netting capital gains and losses against each other also applies to cryptocurrencies. So you can deduct capital losses and realize a net loss of up to $3,000 each year. If your net losses exceed this amount, you’ll have to carry them over to the next year.
5. Crypto miners may be treated differently from others
Do you mine cryptocurrency as a business? Then you might be able to deduct your expenses, as a typical business would. Your revenue is the value of what you produce.
“If you mine cryptocurrency, you realize income at the fair market value, so that’s your basis in the cryptocurrency,” says Harris. “If this is a trade or business, your expenses may be deductible.”
But that last bit is the key point: You have to be running a trade or business to qualify. You can’t operate your mining rig as a hobby and enjoy the same deductions as an actual business.
6. A gift of crypto is treated the same as other gifts
If you’ve given cryptocurrency to someone, perhaps a younger relative as a way to spark interest, your gift will be treated the same way as any similar gift would be. So it can be subject to the gift tax if it’s over $17,000 in 2023 or $18,000 in 2024. And if it comes time for the recipient to sell the gift, the cost basis remains the same as the giver’s cost basis.
That said, you can escape the gift tax if you go over the annual threshold, by taking advantage of the lifetime exemption.
7. Inherited cryptocurrency is treated like other inherited assets
Inherited cryptocurrency is treated like other capital assets that are passed from one generation to another. They may be subject to estate taxes if the estate exceeds certain thresholds ($12.92 million in 2023; $13.61 million in 2024).
Like stock, cryptocurrency enjoys a stepped-up cost basis to the fair value on the day of death. So generally, cryptocurrency is treated for most people like a typical capital asset, says Harris.
8. The wash-sale rule does not apply to cryptocurrency
While the IRS treats cryptocurrency mostly as it does capital assets, it takes a totally different approach when it comes to wash sales. And that’s actually beneficial for crypto traders.
Normally, when a trader sells an asset and declares a loss, the trader must not have purchased the asset (or a very similar one) within 30 days before or after the sale. If the trader repurchases the asset within that 30-day window, it’s declared a wash sale. So the loss can’t be claimed as a write-off until the trader refrains from purchasing the asset within at least the 30-day window.
But the wash-sale rule does not exist for cryptocurrency. So traders can sell their position, book a loss and then literally repurchase the asset moments later and still be able to claim the loss. That rule is advantageous because it allows traders to capture the full value of the tax loss while still being invested, effectively, meaning it’s riskless to actually avail yourself of the tax write-off.
But legislators have been discussing closing this loophole, so it may not exist much longer.
Bottom line
It can be surprisingly onerous to actually use cryptocurrencies, from tracking your cost basis, noting your effective realized price and then potentially owing tax (even without an official Form 1099 statement). Plus, the IRS is stepping up enforcement and surveillance on potential tax evasion by looking more closely at who’s exchanging cryptocurrencies.