Red Flags in Your Crypto Transactions That Could Trigger an IRS Audit

Cryptocurrency offers exciting new opportunities for investors, traders, and enthusiasts to jump in and build wealth. But as opportunities present themselves and digital assets grow in popularity, you can also expect an increase in targeted actions against non-reporting, misclassification of transactions, and overlooked taxable events from the IRS.

In this post, the team at Onchain Accounting will wear the hat of your crypto CPA and walk you through the common red flags in crypto transactions that can raise eyebrows with the IRS and what you can do to protect your portfolio and stay compliant.

Table of Contents

What are the red flags that can trigger an IRS audit?

In our line of work, we find that even the savviest crypto investor is sometimes unaware or underestimates how closely the IRS monitors the activity of digital assets. As such, there are certain behaviors and reporting patterns that can raise an eyebrow with the IRS and potentially draw a full-scale investigation. They include:

Failing to report all taxable events—one of the most common mistakes we come across is investors simply not reporting all the relevant taxable events. When there is a discrepancy or gap in the filings, it can trigger IRS scrutiny.
Mismatched reporting—Incorrectly filing documents and forms such as 1099-B, 1099-K, or Form 8949 can throw all your tax filings in disarray and trigger a discrepancy notice like CP2000.
Inconsistent cost basis or missing records—Poor record keeping can lead to miscalculations of capital gains and losses. The IRS can assume a cost basis of zero if you cannot produce records, making the entire sales proceeds taxable.
Failing to record airdrops and staking rewards—In certain circumstances, assets you obtain from airdrops and staking rewards can be subject to tax, and failing to report can trigger an IRS inquiry.
Transactions with anonymous or overseas exchanges—Significant transactions involving offshore and anonymous exchanges can raise suspicions of illegal financial conduct with the IRS.
Claiming unrealistic losses—Harvesting high losses without proper documentation or reporting can look suspicious and trigger an investigation.

What steps can you take to mitigate the risks of an IRS audit?

Just because you know that the IRS is monitoring transactions does not mean you have to walk on eggshells. By building strong habits on reporting and documentation and many other steps, you can significantly reduce the likelihood of IRS scrutiny. The steps that can be taken to mitigate the risks of an IRS audit include:

Keeping complete and accurate records of transactions
Record all taxable events without any exceptions
Use specialized tax software to help organize your transactions and generate the necessary IRS forms.
Avoid mixing personal and business crypto activities.
Staying updated on IRS crypto guidelines
Get the services of a crypto bookkeeper to review your records and correct inconsistencies.

Conclusion

The IRS has continued to increase its scrutiny and observations in the world of cryptocurrency. From unreported taxable events to inconsistent cost basis methods, there are a number of activities that can raise eyebrows with the IRS and even trigger full-scale audits and investigations.

If you’re looking for help to review records, file documents, and correct inconsistencies, then Onchain Accounting is your strongest ally. Our team of crypto bookkeepers and specialists understand the nuances of the blockchain and how the IRS goes about investigating transactions. That is why we are able to identify issues and help you remedy them before the IRS finds out and tries to initiate audits. Stay compliant and audit-free, and thrive in the world of crypto with Onchain Accounting.