Federal tax law treats cryptocurrency as property. In practice, this means that nearly every crypto transaction is a taxable event. Selling or exchanging crypto (including using it to buy goods or other crypto) generally generates a capital gain or loss based on the difference between the fair market value (FMV) when you acquired the asset and when you disposed of it. By contrast, if you receive cryptocurrency as payment or compensation (for example, wages, independent contractor pay, mining, airdrops, etc.), the receipt is treated as ordinary income equal to the coin’s FMV on the date you gained “dominion and control”. For instance, crypto earned by mining or staking is immediately taxable: the IRS says mining rewards create income equal to the FMV of the coins at receipt, and proof-of-stake staking rewards likewise count as gross income when received. Likewise, airdrops from a hard fork are ordinary income (FMV when received), whereas a protocol change without an actual coin distribution (a “soft fork”) is not a taxable event. In short: receive‐type events (service payments, mining, staking, airdrops) ⇒ ordinary income; dispose‐type events (sales, exchanges, purchases with crypto) ⇒ capital gain/loss.
How Different Crypto Transactions Are Taxed: Capital Gains vs. Ordinary Income
Sales and Exchanges (Capital Gains)
When you sell crypto for fiat currency or swap one coin/token for another, you realize a gain or loss. This is calculated as proceeds minus adjusted basis, i.e., the sale price minus the original cost (including any applicable fees). Gains are short-term if held ≤1 year (taxed at ordinary rates) or long-term if held >1 year (lower capital-gains rates federally). Importantly, the IRS has made clear that like-kind exchange rules (IRC §1031) do not apply to cryptocurrency trades– every crypto-for-crypto swap is a taxable sale (unless part of a tax-deferred account).
Receipt as Payment (Ordinary Income)
If you receive crypto for services or goods, the FMV on receipt is included in income. For employees, that becomes wage income subject to withholding; for contractors, it’s self-employment income. Crypto mining is also considered to be self-employment income. Staking rewards are treated as ordinary income at the fair market value when received as mentioned in IRS Revenue Ruling 2023-14.
Hard Forks and Airdrops
Under Rev. Rul. 2019-24 and IRS FAQ, a hard fork + airdrop creates ordinary income on receipt of the new coins. If a fork occurs but you do not actually receive new coins, there’s no immediate tax.
NFT Sales and Purchases
Non-fungible tokens (NFTs) are taxed similarly to other cryptocurrency assets. Selling an NFT for more than your basis yields a capital gain (short or long term). If an NFT meets the IRS definition of a collectible (codified in Sec. 408(m)), any long-term gain would be taxed at up to 28% instead of the usual 15%. The IRS has issued Notice 2023-27 seeking comments on treating certain NFTs as collectibles, which, when finalized, could affect the tax rate on NFT gains. Until then, most NFT trades follow standard property rules (cap gain or ordinary, depending on how you acquired it).
DeFi, Loans, and Liquidity Pools
The IRS has not issued specific guidance on many DeFi activities. In general, however, actions in decentralized finance still follow basic tax principles: trading one cryptocurrency for another or swapping tokens (e.g., in a decentralized exchange or liquidity pool) constitutes a taxable disposition of property (capital gain/loss), similar to any other trade. Earning yield or interest from lending or liquidity mining is treated as ordinary income equal to the FMV of tokens at receipt. In short, each DeFi event should be analyzed under existing tax law, and reasonable reporting – treating swaps as sales and rewards as income – is prudent. (Notably, the IRS’s new broker-reporting regulations exclude certain DeFi events from reporting for now, but taxpayers remain obligated to report gains and income from those transactions.)
Cost Basis and Accounting Methods
Determining the cost basis of each crypto unit is crucial. Your basis is generally the USD amount paid (including fees and commissions) to acquire the crypto. When you later sell or spend that crypto, the gain/loss is computed as the sale proceeds minus your adjusted basis. For individuals and businesses alike, a methodical tracking basis is required. Taxpayers may use different accounting methods to assign costs to specific coins. The IRS permits Specific Identification (if you maintain detailed records of each lot) or defaults to First-In, First-Out (FIFO) otherwise. Under proposed regulations (Revenue Procedure 2024-28), if you sell crypto and do not specifically identify which units are sold (by date/time or other unique identifier), the IRS will assume you sold the earliest-acquired coins first. (IRS-proposed rules effectively disallow LIFO; any reasonable method must be applied consistently and substantiated.) In practice, using specific ID allows sophisticated taxpayers to select lots (to minimize taxes), but requires meticulous record-keeping; otherwise, FIFO is used by default. Brokers will soon help: by 2026, many crypto platforms are expected to report cost basis on Form 1099-DA, easing the burden of tracking basis. Taxpayers with holding on multiple exchanges/wallets are expected to make reasonable allocation of their basis for their entire crypto holdings on all platforms and report this to each exchange. If a reasonable allocation of basis was made prior to January 1, 2025, and can be supported, Taxpayer’s maybe able to avoid penalties from the IRS in the event of an audit if basis is found to be incorrectly applied.
Reporting Cryptocurrency Transactions
Taxpayers are required to report cryptocurrency transactions on their tax returns. For individuals, capital gains/losses go on Form 8949/Schedule D, and ordinary crypto income (wages, self-employment, mining, etc.) is reported on Form 1040 (with usual schedules). Notably, the IRS Form 1040 now includes a checkbox question (Schedule 1) asking if you “received, sold, exchanged, or otherwise acquired any financial interest in any digital asset.” You must answer “Yes” if you had any crypto transactions to report. Beginning in tax year 2025, custodial crypto brokers (including exchanges, wallets, and kiosks) must issue a new Form 1099-DA to report your crypto sales and proceeds. This information will be provided to both taxpayers and the IRS, similar to brokerage reporting for stocks. (For 2025, the IRS is granting transitional relief so that late or imperfect 1099-DA filings will not trigger penalties as platforms come into compliance.)
For businesses, cryptocurrency received in the ordinary course (e.g., payment for goods or services) is treated as business income; selling held cryptocurrency could be an ordinary or capital gain, depending on whether it was held as inventory. Corporate taxpayers in California simply include crypto gains in their taxable income (taxed at the standard 8.84% California corporate rate). Companies with crypto holdings must keep similar records of cost basis and report accordingly.
California State Tax Treatment
California state follows federal law in treating cryptocurrency as intangible property. All crypto gains and income are taxable under California state’s income tax: for individuals, this means adding the gain to your state return and paying tax at rates up to 13.3% (the top marginal rate). California does not exempt long-term capital gains or provide special crypto tax rules – any gain reported federally on Schedule D flows through to California as ordinary income at your state rate. Likewise, cryptocurrency income from mining, staking, business receipts, or wages is subject to ordinary California income tax, like any other form of compensation. Corporations (or LLCs taxed as corporations) pay California’s corporate tax (8.84%, or 10.84% for banks) on crypto profits.
(Sales and use tax: Cryptocurrency itself is not “tangible personal property,” so mere crypto-to-crypto trades aren’t sales-taxable. However, using crypto to buy tangible goods is treated like a sale of the goods; the purchase is subject to California sales tax in the usual way.)
Foreign Crypto Holdings, FATCA, and FBAR
U.S. taxpayers holding crypto in foreign accounts or exchanges face additional reporting considerations. Importantly, as of today, virtual currency held only in foreign wallet accounts is not separately reportable on the FBAR (FinCEN Form 114). FinCEN Notice 2020-2 clarifies that “a foreign account holding virtual currency is not reportable on the FBAR (unless it holds other reportable assets)”. In other words, a pure crypto wallet with no other foreign bank or securities balance is currently outside FBAR scope. (That may change: FinCEN has signaled plans to amend the rules to include crypto in FBAR in the future.)
By contrast, if you hold crypto through a foreign financial institution (for example, custody on a foreign exchange that also holds fiat), you should treat that as a foreign account for FBAR and FATCA purposes if thresholds are met. U.S. taxpayers with total foreign financial assets (including such crypto accounts) above $50,000 (individual) or $100,000 (married) at year-end generally must file Form 8938 (FATCA). The IRS has not issued a clear rule saying “no FATCA for crypto,” so practitioners often advise erring on the side of disclosure. In short, foreign exchange accounts often appear as “financial assets” under FATCA, and it is prudent to report them on Form 8938 if the value exceeds the thresholds. Because the guidance is murky, we counsel clients that, “to be on the safe side,” they typically should include significant foreign crypto holdings on FBAR/8938 disclosures.
In all cases, U.S. tax filers must also report any foreign gift or inheritance of crypto (Form 3520) and may owe gift tax if sending crypto abroad. Penalties for failing to file FBAR or 8938 can be severe (ranging up to 50% of the account balance for willful FBAR violations), so international crypto holdings deserve careful attention.
Penalties, Audits, and Enforcement
Crypto tax compliance is a high‐risk area for tax audits and enforcement. The IRS has made clear it is aggressively pursuing unpaid crypto taxes. For several years, the IRS Criminal Tax Investigation Division has issued thousands of subpoenas to exchanges (so-called “John Doe” summonses) and sent waves of warning letters to taxpayers. By 2020, the IRS sent over 10,000 letters (Notice 6173/6174/6174-A) to crypto investors suspected of unreported gains. These letters indicate that the IRS believes the taxpayer has unreported cryptocurrency income. Letter 6173, in particular, directs recipients to file delinquent or amended returns if necessary, and warns that ignoring it can lead to an audit or a criminal tax referral. (Letters 6174/6174-A likewise urge compliance and warn of scrutiny if discrepancies persist.)
The stakes are high: failing to report taxable crypto income can trigger civil tax penalties (20% accuracy-related penalty, interest on unpaid tax) and, if the failure is willful, exponentially worse criminal tax charges. Both the IRS and California FTB now have data-matching systems and third-party reports to detect unreported crypto. In practice, the best protection is complete and accurate reporting. Voluntary disclosures can remedy late-filing or underreporting, but delaying often increases penalties and audit risk.
Key Points on Compliance: Maintain meticulous records of every crypto transaction (dates, amounts, receipts, FMVs) and report all gains/income on your returns. Respond promptly if contacted by the IRS or FTB. Seek help from experienced dual-licensed cryptocurrency tax attorneys & CPAs early if you discover errors in past filings, as voluntary correction (often before an audit) can substantially reduce penalties.
Contact the Tax Law Offices of David W. Klasing Today
Cryptocurrency taxation intersects complex rules of income tax, international reporting, and evolving guidance. At the Tax Law Offices of David W. Klasing, we have dual-licensed attorneys and CPAs who are highly experienced in cryptocurrency issues. Our team can ensure you calculate your crypto tax liability correctly, select and document an optimal cost-basis method, and comply with all IRS and FTB reporting obligations (including foreign account filings, if applicable). We also assist with tax planning (structuring crypto businesses or investments tax-efficiently), tax audit defense (handling IRS or FTB inquiries and John Doe summons), and voluntary disclosures or Installment Agreements if needed to resolve liabilities.
Remember: every cryptocurrency situation is unique. For instance, a trader on a U.S. exchange might mainly worry about Schedule D and 1099-DA reporting, whereas a blockchain developer receiving ICO tokens or a miner receiving newly minted coins must address additional ordinary-income issues. Similarly, California-based taxpayers must be mindful of state nuances (the FTB does not treat crypto gains any differently, but it can obtain 1099-K data through local exchanges). Our skilled, dual-licensed crypto tax attorneys and CPAs can map these rules to your specific facts, help minimize taxes within the law, and protect you from costly mistakes. We will do everything in our power to ensure you pay as little tax as possible while also meeting all legal reporting requirements.
In summary, calculating crypto tax liability involves (1) identifying taxable events (sales, income, forks, etc.), (2) determining the proper character of each (capital vs. ordinary income), (3) computing gains/losses using the correct basis method, and (4) reporting everything on your tax returns and any required information returns (1099, FBAR, 8938). California state tax follows these same principles. As IRS and California state tax enforcement intensify, we at the Tax Law Offices of David W. Klasing strongly recommend that taxpayers seek qualified guidance. Don’t wait for a notice – call us at (800) 681-1295 or schedule a confidential, reduced-rate consultation online HERE to ensure your crypto tax affairs are fully compliant and optimized.
