What Are Digital Assets for Tax Purposes?

Digital assets are an increasingly common part of the financial landscape, offering new avenues for investment, transactions, and earning potential. Understanding their tax treatment is important for compliance. This article clarifies what constitutes a digital asset under current tax rules and outlines general tax implications.

Defining Digital Assets for Tax Purposes

For tax purposes, the Internal Revenue Service (IRS) defines digital assets as any digital representation of value recorded on a cryptographically secured, distributed ledger or similar technology. This broad definition encompasses various forms of digital value that can be digitally transferred, stored, or traded. The IRS primarily classifies these digital assets as property, not currency, meaning general tax principles for property transactions apply.

This classification originates from IRS Notice 2014-21, which established that virtual currency is treated as property for federal tax purposes. Common examples include convertible virtual currencies like Bitcoin and Ethereum, stablecoins, and non-fungible tokens (NFTs).

Common Taxable Activities with Digital Assets

Engaging with digital assets involves various activities that can trigger tax consequences. Each transaction type has specific rules determining whether it results in capital gains or losses, or ordinary income.

Selling digital assets for U.S. dollars or other real currency is a taxable event. A capital gain occurs if the fair market value (FMV) at the time of sale exceeds the asset’s cost basis; conversely, a capital loss results if the FMV is lower than the basis. The tax rate applied depends on the holding period: short-term capital gains apply to assets held for one year or less and are taxed at ordinary income tax rates, while long-term capital gains apply to assets held for over one year and generally receive lower tax rates.

Exchanging one digital asset for another, such as trading Bitcoin for Ethereum, is also a taxable event. The IRS treats this as a sale of the first digital asset for its fair market value, followed by a purchase of the second digital asset. Similarly, using digital assets to pay for goods or services constitutes a taxable event. This transaction is viewed as a sale of the digital asset for its fair market value at the time of the transaction, and any gain or loss must be recognized.

Earning digital assets through various means is generally considered ordinary income. Income from mining digital assets, such as block rewards, is taxable at its fair market value in U.S. dollars when received. Staking rewards, earned by locking up digital assets to support a blockchain network, are also considered ordinary income when the taxpayer gains dominion and control over them, typically when they are accessible in a wallet.

Airdrops, which are distributions of digital assets to multiple wallet addresses, are generally taxed as ordinary income at their fair market value at the time of receipt. Similarly, if new digital assets are received as a result of a hard fork—a protocol change that creates a new blockchain—they are typically treated as ordinary income based on their fair market value when the taxpayer gains control over them. Gifting digital assets can also have tax implications. While receiving a digital asset as a gift is generally not taxable for the recipient, the donor may have reporting requirements if the gift’s value exceeds certain annual exclusion amounts, such as $19,000 per recipient for 2025, and may count towards a lifetime gift exemption.

Tax Compliance and Record Keeping

Accurate tax compliance for digital assets relies heavily on meticulous record keeping. Records should include the date of acquisition and disposition, the fair market value in U.S. dollars at both times, and the cost basis, including any transaction fees. Documenting the nature of each transaction—such as purchase, sale, exchange, mining reward, staking income, or gift—along with involved wallet addresses, is also beneficial.

For reporting capital gains and losses from sales and exchanges of digital assets, taxpayers typically use Form 8949, Sales and Other Dispositions of Capital Assets. Data from Form 8949 then flows to Schedule D, Capital Gains and Losses, which summarizes overall capital gains and losses.

Ordinary income earned from digital asset activities, such as mining, staking, or airdrops, is generally reported on Schedule 1 (Form 1040), Additional Income and Adjustments to Income. If digital asset income is derived from a business or self-employment, it may be reported on Schedule C (Form 1040), Profit or Loss from Business. Additionally, Form 1040 includes a question asking taxpayers whether they received, sold, exchanged, or otherwise disposed of any digital assets during the tax year, which must be answered truthfully based on transaction activity.