Tax Law Center Blog

The landscape of digital asset taxation continues to evolve, but the core principle established by the Internal Revenue Service (IRS) remains firm: cryptocurrency is treated as property, not currency, for Federal income tax purposes. This foundational ruling, initially laid out in IRS Notice 2014-21, dictates that nearly every transaction involving a digital asset is a potential taxable event requiring meticulous record-keeping and specific reporting.

Guiding taxpayers through the complexities of capital gains, ordinary income, and the required reporting forms is essential for compliance and effective tax planning in this emerging asset class.

The Core Principle: Property Status and Taxable Events

Because the IRS treats Bitcoin, Ether, and other convertible virtual currencies as property (like stocks or real estate), all subsequent disposition events trigger gain or loss recognition. The tax implications fall into two distinct categories:

1. Capital Gains and Losses: The Disposition Rule

A capital gain or loss is realized any time a taxpayer disposes of a digital asset for more or less than their cost basis. It is critical to stress to clients that “disposition” includes far more than just selling crypto for U.S. Dollars (fiat). Taxable dispositions that trigger a capital gain or loss include:

• Selling crypto for fiat currency.
• Trading/Swapping one cryptocurrency for another (e.g., Bitcoin for Ethereum). In this scenario, the transaction is treated as a sale of the first coin for its Fair Market Value (FMV), immediately followed by the purchase of the second coin. The gain or loss is calculated as the difference between the FMV of the coin received and the cost basis of the coin swapped away.
• Spending crypto to purchase goods or services. The gain or loss is calculated as the FMV of the goods or services received minus the cost basis of the crypto spent.

The resulting gain or loss is categorized based on the asset’s holding period: if the asset was held for one year or less, the gain is short-term and taxed at the taxpayer’s ordinary income tax rates. If held for more than one year, the gain is long-term and subject to the more favorable, lower long-term capital gains tax rates.

2. Ordinary Income: The Fair Market Value Rule

Cryptocurrency can also be received in a manner that results in ordinary income, taxable at marginal income tax rates (the same as wages). The amount of income recognized is the Fair Market Value (FMV) of the crypto, denominated in U.S. dollars, on the date and time it was received.

Events that trigger ordinary income include:

• Mining and Staking Rewards: The FMV of the crypto earned from mining or staking activities is included in gross income upon receipt. Furthermore, if these activities rise to the level of a trade or business, this income is also subject to self-employment tax.
• Compensation: Receiving crypto as payment for services rendered, whether as an employee or an independent contractor.
• Airdrops: Generally, airdropped tokens are treated as ordinary income upon receipt if the taxpayer gains dominion and control over them and has performed no services to receive the drop.

The Imperative of Meticulous Reporting

Taxpayers must affirm their digital asset activity by checking the appropriate box at the top of Form 1040. Beyond that simple check box, reporting requires specific forms based on the nature of the transaction:

• For Capital Gains and Losses: All taxable disposition events must be documented on Form 8949, Sales and Other Dispositions of Capital Assets. This form requires the detailed reporting of the acquisition date, disposal date, sale proceeds (FMV), and most critically, the original cost basis for each individual transaction. The totals from Form 8949 are then transferred to Schedule D, Capital Gains and Losses, to determine the net capital gain or loss for the year.
• For Ordinary Income: Income from activities like staking, mining, or freelance payment is reported on Schedule 1, Additional Income and Adjustments to Income, or Schedule C, Profit or Loss from Business (Sole Proprietorship), if the activity constitutes a trade or business.

A note on Information Reporting: While the IRS has finalized regulations requiring brokers (exchanges) to issue the new Form 1099-DA, Digital Asset Proceeds from Broker Transactions, starting with the 2025 tax year, the ultimate responsibility for calculating and reporting the correct basis and gain/loss remains squarely with the taxpayer. Professionals must emphasize that lack of a third-party reporting form does not negate the filing requirement.

Conclusion and Call to Action

The high volume of transactions, the volatility in pricing that complicates FMV determination, and the critical reliance on precise cost basis tracking make cryptocurrency reporting highly prone to error. For the tax professional, this is an area of heightened risk and growing client need. Simple oversights in tracking disposals can quickly lead to substantial under-reporting and trigger potential IRS penalties.

Our firm provides expert guidance and strategic tax planning to ensure your clients are fully compliant with their digital asset reporting obligations. We assist clients in mitigating audit risk and optimizing tax outcomes.

Contact us today for a strategic consultation to discuss how we can partner with you to resolve your clients’ most complex cryptocurrency tax challenges.