Income tax on cryptocurrency trading for U.S. residents

by | Mar 5, 2025 | Blog | 210 comments

Income tax on cryptocurrency trading for U.S. residents

Types of Cryptocurrencies and Their Roles

Digital currencies and crypto are special types of virtual money primarily used for trading. Various virtual currencies, including Luna crypto, Solana crypto, and XRP crypto, along with established options like Bitcoin, Ethereum, Litecoin, and Stablecoins, can be directly exchanged for traditional currency or serve as its alternative. The core purposes of crypto and virtual currency involve functioning as a measurement unit, value storage, and exchange medium. Crypto stands out from other virtual currencies by employing cryptography to secure transactions. These transactions get digitally recorded on a blockchain, which acts as a distributed ledger. Crypto transactions are categorized into two types: “on-chain” (logged in the distributed ledger) and “off-chain” (not recorded in the distributed ledger).

How Crypto is Taxed

In 2014, the U.S. Internal Revenue Service published Notice 2014-21. It defines crypto as property for federal tax purposes. This means that crypto market transactions are subject to the general tax principles applicable to property transactions. Also, virtual currency (e.g., cryptocurrencies) is not considered currency in the context of determining gain or loss from exchange rate changes for U.S. tax purposes. In other words, while crypto and virtual currency may be used as a medium of exchange or for investment, it does not qualify as currency in the tax sense. Transactions in foreign currencies that result in a gain or loss due to a change in exchange rate may be subject to taxation. However, the crypto market cap and virtual currency are not subject to such rules. For example, if there is a sale of crypto, the gain or loss will be calculated based on the difference between the purchase and sale price of the crypto, not on exchange rate changes.
The value of the crypto in US dollars is determined at the time of receipt. It is this value that will be the basis for calculating tax liabilities in subsequent transactions. For tax purposes, all transactions with crypto should be accounted for in US dollars. For example, when paying with Bitcoin for goods, its value should be converted into USD at the time of the transaction. Income tax appears if the value of the crypto is less than the amount of property purchased. For instance, the cryptocurrency Ethereum was bought for 2500 dollars, and then it was exchanged for something worth 2800 dollars. In this case, there would be a profit of 300 dollars (2800 minus 2500), and tax would have to be paid on it.

How to Calculate Capital Gains Tax

Crypto users need to pay capital gains tax upon selling their investments at profits. You generate capital gains whenever you dispose of an asset that sells for above its original purchase value. The main tax categories are short-term capital gains when crypto is held for less than a year and long-term capital gains when held more than a year before a profitable sale. Using crypto financial losses allows you to subtract costs from other capital gains such as stock and real estate market income. Tax loss harvesting represents the technical process of using capital loss deductions.

Self-Employment Tax and Crypto Mining Taxes

The system of tax payment for experienced cryptocurrency traders varies separately from capital gains taxation. Self-employment tax serves as the basis for taxation instead of standard capital gains rules.
Crypto mining functions as an operation for generating fresh digital currency. The blockchain recording process requires computer systems that miners operate to verify and track transactions. The acquired cryptocurrency must be reported as income by miners. The evaluation of payment amount occurs through cryptocurrency value comparison at the time recipients obtained it.

How to Report Crypto Transactions

When preparing their tax returns all citizens must respond to a question regarding digital assets. Taxpayers need to utilize Form 1040 together with Form 8949 and Schedule D to report crypto transactions. You must submit these forms together with the purchase date as well as sale date of crypto and its price when purchased and sold along with gain or loss information.

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