How Does the IRS Track Crypto Transactions? (Controversial Strategies?)
How does the IRS track crypto transactions? If you’ve traded, invested in, or earned cryptocurrency, you’ve likely wondered how much the IRS knows about your activity. Crypto is often seen as private because it operates on decentralized networks, which makes it easy to assume that you’re invisible to tax authorities. But the IRS has made crypto tax compliance a priority, and failing to understand how they track crypto could land you in trouble.
This guide explains how the IRS tracks crypto through blockchain analysis, exchange reporting, and legal methods like John Doe summonses. By understanding these processes, you can stay compliant and avoid penalties.
How is Crypto Taxed in the U.S.?
In the US, cryptocurrency is treated as property by the IRS. This means crypto is subject to capital gains and income tax rules. Every time you sell, trade, or use cryptocurrency, it’s considered a taxable event. You’re required to report these transactions, even if the amount seems small.
Here’s how it works: when you sell or trade crypto, the IRS looks at the difference between what you paid for it (your cost basis) and what you sold it for. If the value increases, you have a capital gain. If it decreases, you have a loss.
Gains are taxed differently based on how long you hold the crypto. Less than a year? It’s short-term and taxed at a higher tax rate. More than a year? You qualify for lower long-term capital gains tax rates, which are comparatively lower.
Check out the official crypto capital gains tax rates of 2024 here.
Receiving crypto as payment is also taxable. Its fair market value when received counts as income and must be reported.
You report crypto gains and losses on Form 8949 and summarize them on Schedule D. Income from crypto payments goes on your Form 1040. Keeping records of dates, amounts, and transactions is crucial for staying compliant and avoiding IRS penalties. Read out our guide on tracking crypto transactions for tax season to learn more.
The IRS began cracking down on crypto tax compliance in 2014. Since then, they’ve ramped up efforts to track unreported transactions. Today, ignoring IRS crypto tracking isn’t an option.
Read our U.S. crypto tax guide for more in-depth info.
Why does the IRS Track cryptocurrency?
The IRS tracks cryptocurrency because its unique nature makes it easy to misuse for tax evasion. Blockchains like Bitcoin and Ethereum publicly record all transactions, but they don’t link directly to a person’s identity. This makes it harder for the IRS to track who owes taxes on crypto gains or income.
Decentralized finance (DeFi) platforms and peer-to-peer networks add another layer of complexity. These systems operate outside traditional banks, making transactions harder to trace.
For the IRS, the stakes are high. Cryptocurrencies represent a growing share of the economy, and failing to regulate them properly risks widening the tax gap—the difference between taxes owed and collected. Ensuring people pay what they owe helps fund public services and keeps the tax system fair for everyone.
Recent cases show why this is important. In 2024, Roger Ver was charged with avoiding $48 million in taxes by underreporting his Bitcoin. Such actions not only recover lost revenue but also deter others from attempting cryptocurrency tax evasion.
To address this, the IRS uses several different strategies, which is what we’re going to discuss next.
How Does the IRS Track Crypto Transactions?
Third-Party Reporting
The IRS relies on third-party reporting from crypto exchanges to track transactions and catch taxpayers who don’t report their crypto income. Platforms like Coinbase and Kraken have to follow Know Your Customer (KYC) rules. This means they collect info like your name, address, and Social Security number before letting you trade. Once they have this, they share it with the IRS. If the IRS spots something unusual or sees a mismatch in your reporting, they can link your wallet to you.
Exchanges also report how much you make from selling crypto. This helps the IRS figure out if what you reported matches your actual trades. Starting in 2025, exchanges will use a new form, 1099-DA, to share even more details about your crypto activities. There’s been some debate about this, which we’ve covered here.
Another example of third-party reporting is the Infrastructure Investment and Jobs Act. This law expanded the definition of “broker” to include digital asset providers. While it’s meant to close loopholes, it’s caused its own set of issues.
Blockchain Analysis
The IRS uses blockchain analysis tools to track crypto transactions and find people who don’t report their income. They team up with private companies like Chainalysis to dig into public blockchain data. While crypto transactions seem anonymous, these tools can link wallet addresses to real identities by spotting patterns and tracking activity on exchanges.
Once they figure out who owns a wallet, the IRS checks if that person reported their crypto income. If they don’t, they can face penalties or even legal action.
A good example is the case of James Zhong. In 2021, the IRS worked with Chainalysis to recover over 50,676 Bitcoin worth $3.36 billion. Zhong had stolen it from the Silk Road marketplace back in 2012. Using blockchain tracking, investigators followed the stolen funds and linked them to Zhong, leading to a massive recovery. Read the official report here.
Blockchain analysis makes it much harder to hide crypto income. It’s one of the IRS’s most effective tools for enforcing crypto tax compliance and catching non-payers.
John Doe Summons
The IRS uses John Doe summonses to find people who might not be paying taxes on their crypto. These summonses are sent to crypto exchanges, asking for information about users making big transactions. Instead of targeting specific people, the IRS asks for data on a group of users to figure out who might be underreporting their income.
For example, in 2016, the IRS issued a John Doe summons to Coinbase. They wanted information on users with significant crypto activity. Coinbase pushed back, saying the request was too broad and invaded user privacy. By 2018, Coinbase handed over data on about 13,000 accounts. This marked a big win for the IRS in tracking unreported crypto transactions.
In 2021, Kraken faced a similar summons. Kraken also argued it was too broad but eventually agreed to provide limited data.
John Doe summonses work well for catching non-payers, but they can be controversial. Critics say these broad requests invade privacy and put extra pressure on exchanges. For the IRS, though, it’s a key tool to enforce crypto tax laws and make sure everyone plays fair.
FAQ
How does the IRS monitor cryptocurrency wallets?
The IRS monitors cryptocurrency wallets by using blockchain analysis tools and data from crypto exchanges. Tools like Chainalysis help the IRS trace transactions on public blockchains and connect wallet addresses to real people.
Exchanges also play a big role. When you use platforms like Coinbase or Kraken, they collect your personal details through Know Your Customer (KYC) rules. These details, like your name and Social Security number, can be shared with the IRS to track wallet ownership and ensure taxes are reported correctly.
By combining these methods, the IRS can figure out who owns a wallet and check if they’ve reported their crypto income properly.
What triggers an IRS audit for crypto?
An IRS audit for cryptocurrency can be triggered by several things. The most common reason is unreported or underreported crypto transactions. If the IRS sees a mismatch between your tax return and the data they get from exchanges, it could raise a red flag.
For example, platforms like Coinbase and Kraken report user transactions to the IRS. If you sell or trade crypto but don’t report it, the IRS may notice. Large or unusual transactions, frequent trading, or using offshore exchanges can also get their attention.
Failing to report income from activities like staking, mining, or decentralized finance (DeFi) can be another trigger. To avoid audits, make sure to report all your taxable crypto activity, keep detailed records, and follow IRS guidelines for crypto tax compliance. But in case you do get audited, read this guide to know what to do next.
How to avoid IRS penalties for crypto taxes?
To avoid IRS penalties for crypto taxes, report all your crypto activities accurately and on time. This includes any gains or losses from selling or trading crypto, as well as income from mining, staking, or airdrops.
Keep clear records of your transactions. Make note of dates, amounts, and the fair market value of your crypto at the time. Using crypto tax software, like Bitcoin.Tax, can help you organize this information and make reporting easier.
Make sure the information on your tax return matches what exchanges report to the IRS. If you’ve made mistakes in past filings, you can file an amended return to fix them. Read this to learn how to do that.
Lastly, pay any taxes you owe by the deadline to avoid extra fees or interest. If you’re unsure about the rules, consult a tax professional or read our crypto tax penalty guide to learn more.