If you said words like “Bitcoin” or “Ethereum” to the average American ten years ago, they might have asked you to repeat yourself—or simply rolled their eyes. If they weren’t out of the loop entirely, they might have dismissed cryptocurrency as a fad.

But in 2025, crypto has gained traction as an asset class for both private and institutional investors. Some businesses—including popular brands like AMC Theatres and Starbucks—even accept it as payment.

In fact, crypto has become so ingrained in everyday financial trade that some may forget that, although it’s a digital asset, cryptocurrency is treated as a capital asset (or property) by the IRS and most state tax departments. In other words, your crypto stash is subject to ordinary income tax, capital gains, and even estate taxes.

Depending on how well you manage them, crypto transactions can either amplify or thwart your portfolio’s gains. Below, we’ll clarify the nature of cryptocurrency taxation, the risks of failing to report taxable items, and how to protect yourself against costly mistakes.

The Nature of Crypto Taxation

As mentioned, crypto is taxed just like a capital asset. That means you create a tax obligation when you buy, sell, or exchange cryptocurrencies, recognize (or “cash in on”) your crypto’s increase in value, or even spend it like cash in a transaction. To briefly illustrate:

• Buying crypto = cost becomes basis (taxable when disposed)
• Exchanging crypto for cash = taxable event
• Exchanging one cryptocurrency for another = taxable event
• Spending crypto on goods or services = taxable event
• Receiving crypto for goods or services = taxable event
• Gifting crypto = potential taxable event, depending on the donor’s cost basis
• Gains from mining crypto = taxable event
• Selling crypto for gains = taxable event

As you can see, crypto is an innately tax-burdened asset. What’s worse, the penalties for underreporting or failing to report taxable events can be just as daunting—reaching as high as 40% of the underreported tax, in some cases, or up to 75% if the case goes to civil trial.

The outlook for taxpayers who challenge the IRS on crypto reporting at a criminal level is even bleaker: Over half of those audited by the IRS wound up facing prosecution.

So while there are many myths and misconceptions surrounding the taxation of crypto, if you engaged in the transactions above (amongst others), it’s safe to assume you may be facing a tax obligation—even if there was no gain or loss on the transaction and even if you don’t receive an official tax form.

And with penalties like those, it’s better to be safe than sorry.

Reducing Crypto’s Risk—and Increasing Its Efficacy

On top of ensuring you report all taxable events discussed above, there are three other surefire ways to dramatically reduce the risk of crypto in your portfolio:

• Avoiding phantom gains
• Considering crypto ETFs (exchange traded funds)
• Working with a crypto tax advisor

Let’s take a closer look at each of these.

Phantom gains can arise when a taxpayer can’t substantiate the basis in their crypto assets, has to use a conservative or default method to calculate their basis, and is ultimately liable for more tax than they would have if they could support their original basis.

For example, let’s assume a taxpayer buys Bitcoin and has a basis of $30k in the asset. Then they continue to purchase more Bitcoin each month, changing the basis. If that person doesn’t have the best record-keeping skills—for instance, making transactions across multiple platforms or lacking an audit trail on purchases—they likely won’t be able to prove their $30k basis. A conservative basis calculation method might state their basis is only $10k.

In this example, that taxpayer would be exposed to unwarranted tax on the $20k “gain” they recognized due to the discrepency—on top of the tax on the price appreciation. Long story short: It’s well worth the time it takes to keep meticulous records of all your crypto purchases. You might even consider sharing it with your trust advisors to avoid unpleasant tax season surprises.

Investing in a crypto ETF (i.e., a Bitcoin ETF) can further mitigate your risk. Crypto ETFs offer a streamlined way to gain diversified exposure to digital assets without the burden of managing countless individual transactions. Fund managers handle the underlying assets and transaction records as well, effectively eliminating the likelihood of phantom gains and simplifying tax reporting.

Lastly, working with a crypto-knowledgeable tax advisor is a powerful tool to reduce risk. A specialist in cryptocurrency taxation can help you navigate the evolving regulatory landscape and ensure that every transaction is accurately recorded and reported. They can identify potential pitfalls and provide tailored strategies to optimize your tax liability, ultimately saving you from costly penalties—and keeping cryptocurrency a boon in your portfolio, rather than a burden.

Crypto Moving Forward

With a market cap currently above $3 trillion—surpassing industry giants such as Apple, Microsoft, Tesla, and Amazon—and new policies being passed under the current administration to further bolster the market, cryptocurrency may indeed be here to stay.

As crypto continues to evolve, understanding its tax implications and mitigating potential risks is crucial for protecting your portfolio. Here at Felton & Peel, we aim to be a part of your strategic crypto team of advisors—providing insight on reducing all types of risk in your portfolio and ensuring your strategy will thrive. We’re here to help—and your first consultation is on us.

*Please consult your tax advisor when reporting crypto transactions.