Adam N. Michel
In 2014, the Internal Revenue Service (IRS) classified virtual currencies as property for tax purposes, forcing a rapidly evolving technology into the capital gains tax system, which is not designed to handle such diverse use cases. At that time, the global cryptocurrency market cap was less than $10 billion. Today, it’s roughly $3 trillion.
The rise of this industry has prompted congressional action to define the market, clarify regulatory ambiguities, increase reporting, and reform its tax treatment.
In the tax space, cryptocurrencies expose long-standing weaknesses in the capital gains tax. Treating crypto as property forces routine transactions, on-chain participation, and protocol-driven asset creation into a framework that was never designed to handle assets that are used simultaneously for multiple different economic purposes. The result is excessive compliance costs, overly distortionary taxation, and tax liabilities that are often disconnected from true economic gain.
Short of repealing the capital gains tax entirely, Congress can mitigate the worst problems by treating crypto like economically similar things elsewhere in the tax code. It can do this by expanding the foreign currency de minimis exemption and delaying realization until tokens are sold or exchanged.
Taxing Crypto as Property
The core problem with taxing crypto is the capital gains tax. Because cryptocurrencies are used simultaneously as mediums of exchange, speculative investments, and decentralized contracting platforms, they don’t fit neatly into existing tax definitions.
In 2014, the IRS released guidance classifying virtual currencies as property (instead of currency). Under these rules, a taxable capital gain occurs whenever a digital asset is disposed of. This includes selling a digital asset for fiat currency, using a digital asset to purchase goods or services, or exchanging a digital asset for another digital asset or any other property. The creation of new tokens through a hard fork, airdrop, mining, or staking activity is considered ordinary income. (These activities differ mechanically, but all involve the blockchain protocol itself, creating or assigning new tokens; they represent the production of a new asset within the system.)
Selling a cryptocurrency for more than was paid to acquire it (the basis) results in a capital gain (sale price minus basis). That gain is subject to the federal income tax. For assets held for less than a year, capital gains are taxed as ordinary income up to a top income tax rate of 37 percent. For assets held for one year or more, a lower capital gains tax rate is applied. The top capital gains rate is 20 percent, plus an additional 3.8 percent Net Investment Income Tax (NIIT), for a total top rate of 23.8 percent. Where applicable, state income taxes stack on top of the federal rates.
Applying this system to cryptocurrencies creates unworkable compliance obligations and tax liabilities that are often disconnected from liquidity, cash flow, and real economic valuations.
Under the IRS framework, any sale, exchange, or use of crypto triggers capital gains or losses that must be tracked and reported on Schedule D of the taxpayers’ Form 1040. For example, using Bitcoin to purchase a cup of coffee creates a taxable realization event and tax compliance burden. On the Ethereum platform, using Ether (ETH) for transaction fees or “gas” creates a similar taxable event. A taxpayer who used a cryptocurrency multiple times a day could end the year with hundreds of pages of additional tax forms and tax liability.
A similar problem arises when newly created tokens are treated as ordinary income. When a taxpayer receives tokens through an on-platform process, such as staking rewards, current guidance treats the fair market value of those tokens as immediately taxable, even if the tokens are illiquid, locked up, highly volatile, or not readily convertible to cash. This imposes tax liabilities before the taxpayer realizes any economic gain or has cash to pay the tax, turning routine participation in a blockchain network into a source of taxable phantom income.
Capital Gains Tax Reform
The issues with taxing capital gains are not new, nor are they unique to cryptocurrency. The capital gains tax has long distorted the use of assets that function as both stores of value and media of exchange, such as precious metals and electronic payment systems backed by them. More broadly, the capital gains tax increases the after-tax cost of investment by layering a second tax on investment earnings that were already taxed once when they were earned as wages and business income. It also discourages efficient realization by penalizing transactions, creates disparate effective tax rates based on holding periods, and taxes fictitious inflationary gains.
The solution to the capital gains problem is not to treat crypto differently, but to fix the underlying problem of the capital gains tax itself. A tax system that does not double- or triple-tax saving and investment would eliminate most of the tax issues faced by cryptocurrencies.
Eliminating the capital gains tax for all assets would be a good reform. A more structural reform, like a consumed-income tax or other consumption-based system, would tax earnings when they are spent rather than when they are saved, invested, or exchanged, avoiding the need to draw artificial distinctions between investment assets and payment instruments. A reform in the vein of the Hall-Rabushka Flat Tax could achieve this goal without requiring special treatment for cryptocurrencies.
Short of fundamental reform, in a policy environment that remains committed to taxing capital gains, there are two areas where crypto tax reform could substantially improve the taxation of digital currencies and digital assets without creating new distortions or increasing administrative burdens: a meaningful de minimis exemption and the correct treatment of realized gains.
A Meaningful De Minimis Exemption
Congress should adopt a realistic de minimis exemption for crypto transactions, harmonized with the existing exemption for foreign currencies.
Under current law, foreign currency transactions that result in gains or losses from exchange-rate movements are generally taxed as income. In 1997, Congress created a de minimis gain exception, recognizing that taxing trivial gains from personal transactions when traveling is administratively burdensome. For personal, non-business uses of foreign currency, individuals may exempt gains up to $200.
Current proposals, such as the Virtual Currency Tax Fairness Act, often mirror the $200 gain-based exemption used in foreign-currency rules. But that threshold has never been indexed for inflation. A $200 exemption set in 1997 would be about $400 today, and still too low to exempt many economically important transactions.
Other proposals, such as the Lummis-Gillibrand Responsible Financial Innovation Act, take a slightly different approach. The exemption applies only when the total value of the transaction does not exceed $200, and the realized gain does not exceed $200; exceeding either threshold disqualifies the transaction. The total transaction value approach is easier to administer because it avoids calculating basis and gain to determine eligibility. However, a pure transaction-value exemption also pulls a much larger number of transactions into the reporting system once the threshold is exceeded, even when gains are trivial (a problem compounded by the bill’s aggregation rule, which treats a series of related transactions as a single sale).
Rather than shifting to a transaction-value exemption, it would be better to retain the existing gain-based de minimis framework and simply raise the threshold. Increasing the gain exemption threshold to $10,000 (and indexing it for inflation) for all mediums of exchange, including crypto, precious metals, and foreign currency, would better reflect today’s prices and maintain the spirit of the existing framework. Lawmakers could explicitly stipulate that transactions with a total value below the gain threshold are deemed exempt to increase administrative simplicity. This approach expands relief for routine personal transactions without pulling more activity into the reporting system or abandoning the structure Congress already uses for foreign currency.
A harmonized, universal de minimis framework would still capture speculative trading and most long-term investment gains. It would simply prevent the tax code from turning routine personal transactions into unnecessary accounting paperwork. Foreign-currency users already receive this treatment, and there is no principled reason crypto users should be treated more harshly.
Getting Realization Right
Congress must correct the realization rules for cryptocurrencies, particularly for distinct activities, such as mining, staking, hard forks, and airdrops.
Realization is a core concept in capital gains taxation because it marks the point at which the income is both measurable and in the owner’s control. Taxing on-paper income before realization (before the taxpayer has liquid control) risks imposing tax liabilities that are hard to value and exceed the taxpayer’s ability to pay the tax. For example, staking rewards or newly issued tokens at protocol forks can be credited to a taxpayer but remain contractually locked until a withdrawal is triggered, unable to be sold, transferred, or used to pay the tax owed. For that reason, most capital gains are not taxed until a sale is completed. Similarly, self-created property, such as art, is not taxed until a value is determined when it is sold.
Crypto should follow the same principle. Mining, staking, forking, and similar events involve the protocol-driven creation or allocation of new digital assets, not exactly the receipt of income from another party. Taxing these events at the moment of creation mischaracterizes their economic function and creates phantom income when nothing has been sold for an agreed-upon value. Taxing these on-chain activities creates problems, especially when tokens are illiquid or prices are highly volatile. Some proposals, such as the Digital Asset PARITY Act, allow taxpayers to elect to defer realization for five years. This is an improvement, but it still risks forcing liquidation by tying tax liability to an arbitrary date and could create a predictable moment when taxpayers must sell, leading to tax-motivated market volatility. A more coherent approach would defer taxation until the underlying asset is sold or otherwise disposed of, at which point any gain can be taxed.
Extending Other Rules to Treat Crypto Similarly
Beyond realization and limited gain exemptions, Congress should also harmonize crypto tax treatment with a long list of existing rules that already apply to other asset classes. That includes extending wash-sale rules to actively traded digital assets, allowing mark-to-market elections, adding crypto to securities lending rules under Section 1058, and applying constructive sales rules to similar crypto transactions. The goal of these changes should be to align cryptocurrencies with similar transactions as defined in the rest of the tax code. Even where existing rules may be imperfect, it is better to treat similar activities similarly rather than creating special exemptions, crypto-specific penalties, or leaving new technologies in a permanent legal limbo.
Conclusion
Congress should repeal the capital gains tax to free all investment and currency alternatives from the distortions of the tax system. Short of that, crypto does not require a special tax regime. Congress should treat small-dollar-value transactions like it treats foreign currency, delay realization until tokens are sold or exchanged, and extend other similar finance rules to crypto traders. Getting crypto taxation right is ultimately less about digital assets themselves than extending existing frameworks to new technologies.