What the IRS Looks for in Cryptocurrency Transactions

Sep 18 2025 19:00

Cryptocurrency is no longer a niche investment—it’s mainstream. From tech professionals in Seattle investing in Bitcoin and Ethereum to small businesses accepting crypto as payment, digital assets are everywhere. But with this rise comes increased attention from the IRS. If you hold, trade, or sell cryptocurrency, the IRS is watching.

As a tax attorney in Seattle who focuses on IRS disputes and audits, I often get asked: What exactly does the IRS look for in cryptocurrency transactions? Let’s break it down.

Why the IRS Cares About Cryptocurrency

The IRS considers cryptocurrency to be property, not currency. That means every time you sell, exchange, or even use cryptocurrency to pay for goods or services, it could be a taxable event. The IRS is ramping up enforcement, especially as more Seattle residents use crypto for investment and payments.

The IRS has even added a question about virtual currency transactions to the very top of Form 1040 —making it harder for taxpayers to claim ignorance.

5 Red Flags the IRS Looks for in Crypto Transactions

1. Unreported Gains or Losses

If you sell Bitcoin or another digital asset, the IRS expects you to report any capital gains or losses. Failing to include this on your return is one of the most common issues the IRS looks for.

2. Crypto-to-Crypto Trades

Many taxpayers think that trading one cryptocurrency for another (e.g., Ethereum for Bitcoin) isn’t taxable. The IRS disagrees. Each trade is a taxable event, and the IRS actively looks for unreported crypto-to-crypto exchanges.

3. Use of Crypto for Purchases

Buying goods or services with cryptocurrency is treated the same as selling it. The IRS expects taxpayers to report the value at the time of the transaction.

4. Foreign Crypto Accounts

If you’re holding cryptocurrency in overseas wallets or exchanges, the IRS may require additional disclosures. Failing to report these can result in steep penalties.

5. Unexplained Bank Transfers

Large transfers to or from crypto exchanges can raise questions. The IRS uses data-matching technology to flag discrepancies between exchange reports and what you file on your tax return.

How the IRS Tracks Cryptocurrency

Some taxpayers assume crypto is anonymous. In reality, the IRS has sophisticated tools—and partnerships with major crypto exchanges—to identify unreported activity. Through initiatives like “Operation Hidden Treasure,” the IRS has hired experts to trace blockchain transactions.

In Seattle, where many tech professionals are early crypto adopters, this scrutiny is especially relevant.

What to Do if the IRS Contacts You About Cryptocurrency

If you receive an IRS notice or audit request regarding cryptocurrency transactions:

  • Do not ignore it. The IRS is aggressively pursuing digital asset cases.

  • Gather your records. Exchanges like Coinbase or Kraken provide transaction histories that can help rebuild your crypto activity.

  • Seek legal help immediately. A tax attorney experienced in IRS disputes can protect your rights and negotiate with the IRS on your behalf.

Protect Yourself Before Problems Start

The best defense against IRS cryptocurrency scrutiny is proactive compliance. Keep accurate records of:

  • Dates of transactions

  • Value at time of transaction (in U.S. dollars)

  • Purpose (investment, purchase, trade, mining income)