Cryptocurrencies and Taxes: What You Should Know

What began in 2009 with a single virtual currency—Bitcoin—has expanded not just into thousands of cryptocurrencies, but you can now also invest in cryptocurrency funds and crypto futures. But know this: All that virtual activity has real-life tax consequences.

The landscape for crypto taxes is ever-evolving as innovative cryptocurrency assets come to market and new laws and regulations are proposed. Here's how to avoid running afoul of current IRS rules while anticipating potential crypto tax changes to help you plan for the future.

The IRS treats cryptocurrencies as property, not as a currency, meaning any transactions you make using crypto will be subject to the general tax principles applied to other property transactions. Whenever you mine, sell, trade, or exchange cryptocurrency, you will likely trigger a taxable event (see "Taxable vs. nontaxable crypto events").

At the federal level, taxable crypto transactions generally involve the sale or exchange of cryptocurrency, resulting in either a capital gain or loss. Also, if you receive crypto as payment for services rendered, your earnings will be subject to income tax. Be aware that some states may also tax cryptocurrency transactions, so work with a local tax professional to determine potential tax liabilities.

If you hold cryptocurrencies as an investment, the primary tax consideration is realizing either capital gains or losses when you sell, exchange, or use your crypto (see "Calculating crypto gains and losses"). Indeed, most people don't think of shopping as a taxable event, but it can be if you use virtual currencies. When you buy something with cryptocurrency, you're effectively selling a portion of your crypto holdings and using the proceeds to cover the cost of the purchase—if you make money on the cryptocurrency transaction and don't report the capital gains or income, you could be in hot water.

That said, whether the transaction results in a gain or a loss is calculated by taking the difference between the fair market value of the goods or services you purchased and your adjusted cost basis for the crypto used in the transaction—generally the amount you paid for your cryptocurrency, plus any fees.

For example, let's say you use cryptocurrency to purchase a $45,000 car. You originally purchased that crypto on an exchange for $40,000, so buying the car results in a $5,000 gain (ignoring transactions costs). If you held the crypto for a year or less, the tax on the gain would be subject to the short-term capital gains rate, which is the same as your ordinary federal income tax rate—up to 37%. Had you held the crypto for more than a year, you would owe the current long-term capital gains tax of 0%, 15%, or 20%, depending on your tax bracket. You may also have to pay the 3.8% net investment income tax on your gains if your total taxable income is over certain levels.

But what if the initial value of the crypto was $50,000? In this case, paying $45,000 in crypto for the car would result in a $5,000 capital loss, for which you could use tax-loss harvesting to potentially offset your capital gains and then up to $3,000 of your ordinary income. You can also carry over any remaining loss to the next year to offset future gains or income. That said, since cryptocurrencies are considered property and not a "security," any crypto losses are generally exempt from wash-sale rules.

If you operate a business that accepts cryptocurrencies as payment for goods or services, you may face some unexpected tax consequences. As with any business transaction, the IRS sees all exchanges with customers as a taxable event, no matter if it involves cash, credit, bartering, or crypto. When a customer or client pays you in crypto, the income you realize is based on the currency's fair market value at the time of the transaction and will be included in your gross business income.

Since the crypto is property and not a currency, another issue to be aware of is the potential for a capital gain or loss when you eventually sell the crypto you received. For example, a buyer pays you $6,000 in digital currency for a mountain bike. Because you purchased the bike for $4,000, you now have $2,000 of taxable ordinary income on that sale. But your crypto tax implications don't end there. Let's say you hold the cryptocurrency for six weeks. Its value goes up to $7,500 during that time, and you decide to sell it. Your cost basis for the crypto is $6,000, the fair market value on the date you received payment for the mountain bike, resulting in a $1,500 taxable short-term capital gain.

While we recommend all business owners work with a tax professional, if your business accepts cryptocurrency, it's doubly important to have a tax advisor who understands how virtual currencies could impact your taxes.

Investing directly in cryptocurrency can be complex and riskier than other investment types. Investors who want to add digital assets to their portfolio without visiting a crypto exchange or managing a digital wallet, might consider cryptocurrency exchange-traded products (ETPs) instead. But before considering any fund, you should consult the fund's prospectus to understand its investment objectives, risks, charges, and expenses.

That said, here's how two such crypto funds are taxed.

• Spot crypto ETPs hold the cryptocurrency itself, such as bitcoin. When you sell the ETP, any gains will be taxed at either the long- or short-term rate depending on your holding period. You may also owe income tax if the fund sells some crypto coins and realizes a gain.
• Futures crypto ETFs, on the other hand, don't hold the underlying cryptocurrency but rather own contracts representing agreements to buy or sell cryptocurrencies at a future date and price. While these funds are also subject to potential capital gains taxes when you sell the ETF, depending on its structure of the entity, some funds may be subject to IRC 1256 rules which require:
  • Mark-to-market accounting: At the end of each tax year, positions held in Section 1256 contracts are marked to market. This treats the taxpayer as having sold all positions at year end for their fair market value, regardless of whether an actual sale occurred. The fair market value then becomes the new cost basis in that asset.
  • 60/40 tax treatment: For tax purposes, gains and losses from these contracts are subject to the so-called "60/40 rule" that treats 60% of your gain or loss as long-term and the remaining 40% as short-term.

You must report capital gains and losses subject to Section 1256 on IRS Form 6781 when filing your return.

Cryptocurrency transactions are made possible through crypto mining, a process that generates new coins and uses blockchain technology to verify the buying, selling, or exchanging of digital currencies. Crypto mining introduces additional layers of tax complexity due to the dual nature of income recognition—both as ordinary income when you receive the mined coins and as a potential capital gain or loss when you eventually sell or exchange the digital currency.

When you successfully mine new cryptocurrencies, the IRS taxes the fair market value of the coins at the time of receipt as ordinary income—regardless of whether you sell the coins immediately or hold on to them. If you hold on to the coin, the fair market value at the time of receipt becomes your cost basis, which will be used to determine capital gains or losses.

For example, if your mining generates bitcoins worth $5,000, that amount is taxable as ordinary income in the year you acquire the coin. If you later sell the bitcoin at a higher price, the difference between the sale price and the $5,000 cost basis will be treated as a capital gain. However, if you sell the coin for less than $5,000, a capital loss is generated. 

If you operate your crypto mining activity as a bona fide business, the IRS will allow you to deduct ordinary and necessary business expenses—including equipment costs, software, and electricity—against the income you earn from the mining. However, you may also need to pay a 15.3% self-employment tax, which will be applied to your mining profits after taking eligible tax deductions, to cover Social Security and Medicare.

Any coins you mine as a hobbyist are also taxed as ordinary income, but your expenses may not be tax deductible. Whether your crypto activity is a hobby or a business is often not clear, but the IRS has several factors to consider to help you determine how to treat your mining activity on your tax return. We recommend meeting with a tax professional if you are unsure.

Currently, the majority of the tax-reporting burden for crypto transactions lands on the individual taxpayer, and given the complexity of cryptocurrency transactions, recordkeeping is paramount. The IRS expects you to substantiate reported figures and calculations on your tax return, so you'll want to maintain detailed records that include:

• Dates of acquisition and sale
• Purchase and sale prices in U.S. dollars
• Quantities of each transaction
• Purpose of the transaction (investment, payment for goods or services, wages, etc.)

Some people believe crypto transactions are untraceable, but blockchain technology creates a permanent public ledger and cryptocurrency exchanges record all transactions. This transparency makes tracking the flow of funds possible, allowing taxing authorities to analyze such records and link transactions to individuals or entities.

And starting in 2025, crypto exchanges must report certain digital asset sales and transactions on Form 1099-DA. Gains and losses for cryptocurrency funds or regulated futures, however, will continue to be reported on Form 1099-B. But remember, even if you don't receive any tax forms, you must report all taxable crypto transactions to the IRS on your personal tax return.

Tax regulations continue to evolve, so professional guidance can help ensure you don't run afoul of both federal and state tax rules—especially if you operate a crypto mining business or engage in high-volume trading. Underreporting income, recording transactions improperly, and inaccurate documentation could lead to a tax audit, significant penalties and interest, or even prison sentences. We recommend you work with a CPA or tax attorney to review your situation and correct any errors as soon as possible.

At the federal level, generally you'll owe tax on crypto earnings and realized capital gains or losses from the sale or exchange of cryptocurrency. Here's a rundown of what crypto activity will trigger a taxable event.

You can potentially minimize your crypto tax liability in several ways, including:

• Hold it long-term to get a lower tax rate. Holding crypto for more than one year allows you to qualify for lower long-term capital gains tax rates.
• Harvest tax losses. Selling underperforming crypto assets at a loss may allow you to offset other capital gains and up to $3,000 of ordinary income. The same is true with using losses from other investments to offset crypto gains.
• Gift it. Gifting crypto to loved ones can potentially allow for a tax-free wealth transfer if the value of the gift is below the annual or lifetime gifting limits. If the person receiving the gift is in a lower tax bracket, they can sell the asset with less tax impact.
• Donate it to charity. If you itemize your deductions, donating crypto to a qualified charity may allow you to deduct the fair market value of an asset held long-term without incurring capital gains taxes.
• Use tax-advantaged accounts. You can hold crypto assets within some tax-advantaged accounts, such as a self-directed IRA. Holding assets in tax-advantaged accounts may allow you to defer taxes, in the case of a traditional IRA, or avoid the distribution of taxes altogether with a Roth IRA.

An estate planner, financial advisor, and tax professional can help you develop a cryptocurrency tax strategy that aligns with your financial goals.

Cryptocurrency taxation in the U.S. is complex, but understanding the current rules can help you avoid penalties and maximize the tax efficiency of your digital investments. Whether you're a miner, investor, business owner, or casual trader, proper recordkeeping and strategic tax planning can help reduce your tax burden while ensuring compliance with IRS regulations. For those with large or complex crypto holdings, consult a crypto-savvy tax professional to help ensure full compliance while maximizing tax-saving opportunities.

Also, crypto tax rules are ever-evolving, so if you're not sure how to report your crypto transactions properly, work with a tax advisor—and file an amended return as soon as possible for any past missteps.