A cryptocurrency IRS audit is when the IRS examines a taxpayer’s return to verify they properly reported crypto-related income, gains/losses, and disclosures. Crypto audits often focus on whether someone underreported taxable events or failed to disclose accounts/transactions.
Below is what we typically look for to help clients (and what the IRS is usually looking for).
What triggers a crypto IRS audit (common reasons)
- High crypto volume (many trades, DeFi activity, NFTs).
- Large proceeds reported on a 1099 (like 1099-B / 1099-DA / 1099-MISC / 1099-K) that don’t match the return.
- Schedule D doesn’t reflect reality (missing gains/losses).
- Mismatch between reported income and lifestyle (bank deposits, spending, etc.).
- Failure to answer the crypto question on Form 1040 accurately.
- Prior audit history or prior noncompliance.
- Large withdrawals from exchanges to bank accounts.
- Significant staking/mining income with no matching reporting.
What we look for when helping a client in a crypto audit
1) The full crypto transaction history (the backbone)
We gather and reconcile:
- Exchange trade history (Coinbase, Kraken, Binance.US, etc.)
- Wallet activity (hot wallets, cold storage)
- On-chain transfers
- Fiat deposits/withdrawals
Goal: rebuild the complete “ledger” of what happened and when.
2) Taxable events the IRS cares about most
The IRS generally focuses on:
- Sales of crypto for USD (capital gains/losses)
- Crypto-to-crypto trades (also taxable)
- Spending crypto (buying goods/services triggers gain/loss)
- Receiving crypto as income, including:
- staking rewards
- mining rewards
- airdrops (often disputed timing, but commonly examined)
- referral bonuses
- payments for services in crypto
- NFT sales/mints/trades
- DeFi transactions (swaps, LP activity, yield farming)
3) Cost basis + gain/loss accuracy (big audit issue)
This is usually the core issue.
We check:
- Did they calculate cost basis correctly?
- Are they using FIFO / specific identification appropriately?
- Is basis missing (very common when coins move between wallets/exchanges)?
- Are fees accounted for correctly?
- Did they report proceeds but no basis, accidentally creating inflated tax?
IRS red flag: large proceeds with little or no basis support.
4) Transfers vs. sales (misclassification errors)
A common audit problem is when software marks transfers as taxable sales or the reverse.
We verify:
- Wallet-to-wallet transfers are properly labeled non-taxable
- Exchange deposits/withdrawals aren’t mistakenly treated as disposals
5) Income reporting (staking/mining/airdrops)
We look for missing income on:
- Schedule 1 (Other income)
- Schedule C (self-employment, mining as business, crypto services)
- Business deductions (if applicable)
We also check whether income was reported at a reasonable fair market value at receipt.
6) Form 8949 + Schedule D support
We make sure the return has:
- Proper Form 8949 detail
- Totals tying cleanly into Schedule D
- Any reconciliation statements if totals were aggregated
Auditors frequently ask for:
- Exchange statements
- Tax software reports
- How numbers were calculated
7) Offshore issues (if applicable): FBAR / FATCA
If the client used foreign exchanges/accounts, we evaluate:
- FBAR (FinCEN 114) filing requirements
- Form 8938 (FATCA) issues
These can escalate a “simple crypto audit” into a much bigger compliance problem.
8) Unreported accounts / wallets / identity links
We assess:
- Whether accounts were opened under different emails/IDs
- Use of multiple exchanges and wallets
- Whether there are blockchain links suggesting undeclared wallets
The IRS may already have some data through:
- exchange reporting
- John Doe summons-related disclosures
- blockchain tracing
9) Wash sale misunderstanding
Many clients assume crypto wash sales work like stocks.
Currently, crypto wash sale rules have historically not applied the same way as securities (rules can change and proposals exist), but the IRS still audits for abusive patterns and inconsistent reporting. We look for:
- “loss harvesting” patterns
- aggressive basis reporting
- inconsistent positions year to year
What we do to help clients (practical audit defense approach)
Our typical audit-support checklist:
- Confirm scope + year(s) being examined
- Get the IRS notices + IDR requests (what they’re asking for)
- Pull complete exchange/wallet records
- Reconstruct accurate gains/losses and income
- Prepare an audit-ready report package
- Identify issues early:
- missing basis
- unreported income
- incorrect transfer labeling
- Recommend strategy:
- support original return if correct
- or file an amended return where needed
- Create an explanation narrative that is consistent, simple, and documented
Biggest mistakes we see (and fix)
- Reporting only 1099 proceeds as profit
- Leaving out crypto-to-crypto trades
- Missing staking income
- Missing basis after transfers
- Mixing personal and business wallets
- Relying on tax software output without verification
- Ignoring DeFi complexity until the IRS asks
What an auditor usually asks for
Common requests include:
- Exchange statements and trade history exports
- Wallet addresses
- Transaction-level gain/loss reports
- Proof of cost basis for large dispositions
- Bank statements showing deposits/withdrawals
- Explanation of the method used to compute gains/losses
Cryptocurrency Audit Tax Attorney Houston