Will the IRS audit you for crypto?

We gathered insights from official tax guidance and our experts to identify the most common triggers for crypto audits. Avoid incomplete transaction histories, unexplained wallet transfers, or inaccurate capital gains/losses frequently, as these can invite scrutiny. Staying organized and documenting every trade is crucial. When in doubt, consult a crypto tax professional for guidance.

What are the odds of a crypto tax audit?

The general audit rate is low, with around 0.68% of taxpayers audited by the IRS in 2023. However, the odds for taxpayers with complex or high-value financial situations, including cryptocurrency investments, can be higher. Since the IRS focuses more on crypto tax compliance, those actively trading crypto may face a slightly elevated audit risk if their reporting appears inconsistent.

TokenTax works with crypto users to ensure they file accurately and minimize audit risk. While the chance of an audit may remain low, crypto taxpayers must file accurately each year to reduce the potential for red flags.

Zac McClure’s expert take

“I’ve never been through an IRS audit myself, but I totally understand the stress and complexities from working closely with our team of crypto tax specialists. Audits might be rare, but they can have serious consequences, especially for those heavily involved in crypto transactions. We got into this field to help people navigate these tricky waters. Knowing the tax rules and staying compliant can really help protect you from the stress of a tax audit.”

— Zac McClure, Co-founder, TokenTax

Ways to avoid a cryptocurrency audit

Crypto investors can reduce their audit risk by taking several proactive steps to ensure accurate reporting and compliance. Critical practices include correctly tracking and reporting all transactions, using crypto tax software, and double-checking tax returns for accuracy.

• Accurately report crypto activity: To avoid discrepancies, include a complete transaction history, the chosen accounting method (FIFO, LIFO, HIFO), and all relevant assumptions in your tax return.

• Use crypto tax software: our platform at TokenTax can simplify filing by syncing transaction data, providing accuracy, and helping ensure compliance with IRS requirements.

• Double-check your tax return: Even minor errors can raise flags. Carefully review calculations, especially if you have multiple transactions.

• Provide additional documentation when necessary: If you have significant gains or income changes, additional documentation can clarify your situation and avoid audit triggers.

• Be cautious about deductions: Large deductions relative to income can increase the likelihood of an audit, so exercise caution when reporting expenses.

These measures, combined with the right tools and professional advice, help mitigate audit risks for crypto investors.

Looking to calculate your crypto taxes? Try our free crypto tax calculator.

How crypto tax audits work

If the IRS selects you for a crypto tax audit, they will notify you by letter. Crypto tax audits may take place by mail or in person, depending on the complexity of the audit. While tax records must be kept for three years, the IRS may examine records going back up to six years if they detect significant errors.

During a crypto tax audit, the IRS will review your financial documents, including crypto transactions, bank statements, credit card payments, and other relevant records. They may use this information to confirm whether the reported income and expenses align with your financial history. The IRS also has crypto experts who assist in verifying complex crypto transaction data. After the audit, the IRS will issue findings and, if needed, allow you 30 days to appeal their conclusions.

Learn more about how to reduce your crypto taxes.

Crypto tax audit types

The IRS conducts crypto audits similarly to standard audits, specifically for cryptocurrency transactions by those engaged in crypto trading or investment. Three main types of IRS audits apply to crypto investors:

• Correspondence audits: The most common type of audit involves the IRS requesting additional information or suggesting adjustments via mail.

• Office audits: In an office audit, the taxpayer visits an IRS office to address particular areas of concern in their return, often focused on specific issues like crypto gains or income discrepancies.

• Field audits: The most comprehensive audit type involves IRS agents visiting the taxpayer’s home or business to conduct an in-depth review of financial records.

Using TokenTax to report your crypto activity and maintain clear records accurately can help reduce the chances of encountering any of these audit types.

Documentation needed for crypto audits

Accurate and comprehensive documentation is essential for a crypto audit. You’ll need to provide a detailed history of crypto transactions and related records for at least three years, though keeping six years of data is advised. Key documents include:

• Dates, values, and gains/losses for each crypto transaction.

• The accounting method used (FIFO, LIFO, or HIFO) for gains/losses. Learn more about

  crypto accounting methods.

• Documentation for each exchange and wallet, including user IDs, email addresses, and IP addresses.

In addition to crypto records, the IRS may request broader tax documents, such as income records, expense receipts, and deductions. Keeping these records accessible helps maintain compliance and can expedite the audit process if selected.

Looking to calculate your crypto profit? Try our free crypto profit calculator.

Most common IRS crypto audit questions

The IRS may ask for several types of information during a crypto audit. Typical questions focus on the following areas:

• Wallet IDs and blockchain addresses: The IRS often requests all wallet IDs and blockchain addresses controlled by the taxpayer.

• Exchange details: This includes user IDs, email addresses, and account numbers associated with exchanges used for crypto transactions.

• Transaction details: The IRS may request dates, values, and amounts for each crypto transaction, as well as the method used to calculate gains or losses.

Providing these details accurately can help satisfy IRS audit requirements and resolve the audit more smoothly.

How far back does a crypto tax audit go?

Typically, the IRS audits tax returns from the last three years. However, in cases where significant errors are found, they may extend their review to six years. This means it’s crucial to maintain tax records for at least three years from the filing date and ideally keep records for six years to be fully prepared for any possible IRS scrutiny.

By law, taxpayers must retain documents used for tax filings for at least three years. Crypto investors, especially those with complex transactions, should consider keeping records longer to ensure they’re covered in case of an extended audit.

How long does a crypto audit take?

The duration of a crypto audit can vary depending on the complexity of the taxpayer’s financial history and the specific issues under examination. Most audits focus on the last three years, but more in-depth investigations may take longer if additional data is required.

There is no fixed timeframe for an audit, as the length largely depends on how much information needs review and how quickly both parties provide the necessary documentation. After the audit, the IRS will issue a letter detailing their findings, and taxpayers have 30 days to appeal if they disagree with the results.

Can the IRS identify my cryptocurrency transactions if I don’t report them?

Yes, the IRS has several methods for tracking crypto transactions, and it’s best to assume they have insight into your activities. Failure to report can lead to penalties, interest, and even criminal charges. The IRS has increased its focus on enforcing crypto compliance.

• Exchanges: Centralized exchanges like Coinbase regularly report user transactions to the IRS.

• Third-party services: The IRS uses blockchain analysis services to trace crypto activity and identify potential discrepancies.

• Patterns and behavior: Large or frequent crypto transactions, especially those involving conversion to fiat currency, may raise red flags with the IRS.

To ensure compliance, report all crypto activities, even on decentralized platforms.

How our tax experts can help you during a crypto audit

An IRS audit requires thorough documentation. Our TokenTax team can provide the information needed for a positive outcome.

We assist clients in managing crypto audits by providing organized data from exchanges and wallets. Our software allows you to compile accurate records and efficiently deliver the required information to the IRS, helping you navigate the audit process.