How IRS exam trends may reshape crypto compliance

Much like other commonly examined aspects of a company’s tax filings, we expect IRS exams of crypto activity to follow a consistent progression: ensure completeness first, accuracy second. Before an examiner evaluates whether gains and losses were calculated correctly, step one is ensuring completeness of all reported activity—every wallet, exchange account, and on-chain address. That threshold question can be much harder to satisfy than it sounds when it comes to crypto transactions. 

Blockchain tracing tools are a standard part of the IRS examiner's toolkit.² Several commercial analytics platforms are used regularly to test whether a taxpayer's disclosed accounts represent their full crypto footprint. Publicly available tools are able to utilize known wallet addresses which can be used as seeds for attribution analysis, surfacing connected addresses and transaction flows that may not have appeared in the taxpayer's initial response and that may have been unknown to the taxpayer to begin with (e.g., movements by administrators between “hot” and “cold” wallets to effectuate trades). Unlike traditional financial accounts, transactions recorded on a public blockchain are, by design, a permanent and openly accessible record. Every transaction is written to a distributed ledger that anyone, including the IRS, can view, and each entry remains there indefinitely. Once the IRS connects a wallet address to a taxpayer, it can trace the full history of activity tied to that address without needing to request records from the taxpayer or a third party. As a result, taxpayers should be prepared to document and explain any on-chain movements of digital assets, whether or not a given transaction results in a taxable event.

The practical challenge is that taxpayers themselves may not always have a complete picture of their crypto history. Examples include wallets opened years earlier and long forgotten, exchange accounts at platforms that have since closed, and one-off interactions with DeFi protocols. These issues are frequently the product of the same complexity that makes crypto recordkeeping difficult for everyone. A thorough pre-exam reconstruction, conducted before the first IDR response is submitted, is far preferable to a series of supplemental productions that can inadvertently raise questions about completeness and credibility.

Once completeness is reasonably established, the exam shifts to accuracy: did the taxpayer correctly identify which lots were disposed of, recover the right tax basis, and report the correct gain or loss? That is where the issues addressed in the following sections, basis substantiation, wallet-by-wallet tracking, and value substantiation, become the central focus.

A transaction reconciliation is about establishing what happened, whereas basis substantiation focuses on proving what it cost upon purchase or acquisition. Taxpayers bear the burden of proving basis and where proof is absent, substantiating basis in an asset  with the IRS can be complex and cause significant tax implications.

Challenges substantiating basis do not only arise at the point of original acquisition and often occur as a result of transfers between wallets and accounts over time. A taxpayer may have solid records of their initial purchases on a major exchange, but if those assets were subsequently moved across wallets, into cold storage, through DeFi protocols, or onto other platforms, and those transfers were not systematically tracked with basis continuity in mind, the documentation chain fractures. Each undocumented transfer creates a potential gap and corresponding exposure associated with the taxable gain or loss on subsequent dispositions. Reconstructing the true picture after the fact is painstaking with many practical challenges.

The problem is exacerbated by the various ways crypto assets can be acquired. Purchases are the most straightforward; there is typically at least a transaction record, even if the exchange no longer exists. But airdrops and hard forks present a structurally different challenge. Under current IRS guidance, the basis in an airdropped or forked asset depends on whether the taxpayer recognized and reported income at the time of the event. If they did, the fair market value included in income becomes the basis. If they did not, which describes a significant portion of early crypto participants who either were not aware of the guidance or operated before it was clearly articulated, then the basis question becomes entangled with a prior-year income inclusion question. Resolving one can implicate the other, and examiners scrutinizing basis in these situations are often, simultaneously, scrutinizing whether the original income event was properly reported. That dual exposure makes airdrops and hard forks among the most difficult basis disputes in exam settings.

The practical implication for exam preparation is that basis documentation needs to be approached as a chain-of-custody exercise, tracing each asset from its origin acquisition through every subsequent transfer to the point of disposition. Where links in that chain are missing, the priority is to reconstruct what is recoverable - exchange records, blockchain transaction histories, contemporaneous communications.  Those who have this documented are in a much more favorable position should the IRS request those records.

For much of crypto's early history, taxpayers and practitioners operated without clear IRS guidance on how to track cost basis across multiple wallets and exchange accounts. The approach that some taxpayers took was a “universal” view: All assets were treated as if held in a single pool, regardless of where and how they were custodied. Under that framework, transferring assets from one exchange to another was irrelevant for purposes of tracking tax basis; the pool simply moved with the taxpayer. It was a practical solution to a recordkeeping problem that neither the IRS nor most software providers had yet addressed directly. Many of the early basis tracking software platforms reinforced this approach simply because universal methodology was the only option they offered.

The simplicity of that approach was its primary virtue. It was not necessarily more or less favorable to taxpayers; it was just easier to administer. But the arrival of broker reporting under T.D. 10000 changed the calculus entirely.³ With crypto brokers now required to report gross proceeds and, eventually, cost basis to their customers and the IRS, the agency's matching program depends on broker-reported figures aligning with what taxpayers report. A universal methodology applied by a taxpayer, layered on top of account-specific reporting from brokers, creates a structural mismatch that undermines any potential utility of that matching program. This tension, more than anything, is what drove the formalization of the wallet-by-wallet (or account-by-account) requirement.

The transition and the Rev. Proc. 2024-28 Safe Harbor  

Moving to a wallet-by-wallet lot selection methodology is not simply a change in accounting convention, it requires taxpayers to reconstruct where their basis actually lives across every account and wallet they hold. For taxpayers with long histories, multiple platforms, and years of transfers between wallets, that is a genuinely difficult exercise. 

Rev. Proc. 2024-28 offered a structured path for making that transition.⁴ To take advantage of it, taxpayers were required to identify all their holdings across every account and wallet as of December 31, 2024, and then reasonably allocate (as described in the Rev. Proc.) the cost basis to each asset in each account or wallet at that point in time. In concept, this was a reasonable mechanism for resetting the basis tracking framework. In practice, it was a significant undertaking.

That gap has direct exam implications. For exams that straddle the pre-2025 and post-2025 periods, the IRS will likely request substantiation showing that the safe harbor was properly implemented. A taxpayer who cannot produce that documentation faces a meaningful risk: The IRS could recalculate gains and losses using the default FIFO methodology. For taxpayers who had been applying specific identification methods, such as HIFO, the difference between their reported figures and an IRS-calculated FIFO result could be material. The safe harbor was designed to provide certainty; without it, that certainty evaporates, and the basis allocation question becomes open to challenge precisely at the point where the old methodology ends and the new one is supposed to begin. In these circumstances, it is prudent for the taxpayer to carefully assess their facts, firm up their books and records, along with lot relief methodologies, and determine supportable positions in prospective filings.

Valuation questions in crypto exams begin at the most basic level: Proving that dollars actually left a taxpayer's bank account and were used to acquire crypto assets. Bank records showing transfers to exchanges, combined with corresponding exchange records showing the purchase, form the foundation of any cost basis claim denominated in fiat. Where that linkage is clean and documented, the valuation question is straightforward. Where it is not, even the most basic purchase basis becomes contestable.

From that foundation, the valuation challenges grow more complex across a range of transaction types.

Crypto-to-crypto exchanges: Each crypto-to-crypto swap is a taxable disposition, and the fair-market-value (“FMV”) of the asset received generally dictates the amount of proceeds realized by the seller. When both legs of the transaction involve liquid, exchange-traded assets, the valuation exercise may be manageable. When a taxpayer exchanges a liquid asset for an illiquid asset with minimal market activity, the amount realized in the transaction may be more difficult to discern. The complexity compounds when both assets are illiquid, because there is no reliable reference point on either side of the transaction, leaving the taxpayer to defend a methodology without the benefit of an observable market price to anchor it.

Hard Forks, Airdrops, Mining, and Staking Rewards: For assets acquired through hard forks, airdrops, mining, or staking, existing IRS guidance suggests taxpayers recognize income for the FMV at the time the taxpayer has dominion and control of the assets.⁵ This recognition event would simultaneously establish the asset's basis in the hands of the recipient. The practical problem is that many of these events involve assets that were illiquid or thinly traded when they were received. Further, the point at which dominion and control over said assets has been established may be difficult to discern. Establishing a defensible FMV when reliable market data is sparse or non-existent requires methodological care, and examiners will scrutinize both the valuation figure and the source used to support it.

Compensation Paid in Crypto: Where crypto is used to compensate employees or independent contractors, FMV at the time of receipt generally governs revenue recognition for the recipient and establishes their basis in the asset. The USD value of these payments may also be reported to the IRS and recipient on forms 1099 or W-2 filed by the payor. Substantiating that FMV, particularly for payments made in smaller or less liquid tokens, requires the same sourcing rigor as any other receipt-based valuation.

Illiquid and Thinly Traded Tokens: Cutting across all of the above is a broader question of what constitutes an acceptable valuation source when exchange data is unreliable or unavailable. Taxpayers relying on data from low-volume exchanges, aggregated pricing services, or internal estimates should be prepared to defend both the source and the methodology. The IRS has not issued comprehensive guidance on acceptable valuation methods for illiquid crypto assets, which leaves the field somewhat open but also means examiners retain significant latitude to challenge the approach.

Donations of Crypto Assets: Because cryptocurrency is treated as property, donations of crypto to charitable organizations require a qualified appraisal for deductions exceeding the applicable threshold, just as a donation of artwork or real estate would. This is an area where taxpayers frequently err, either because they assume crypto is treated more like cash for charitable purposes or because they are unaware of the appraisal requirement entirely. An examiner scrutinizing a large charitable deduction involving crypto will look for the qualified appraisal, and its absence can result in full disallowance of the deduction regardless of the asset's actual value.

A few essential documentation best practices include being contemporaneous, complete, intelligible, and consistent with what the IRS already knows (e.g., third-party filings or publicly available information, including press releases, filings, social media posts, etc.). 

Contemporaneous—The beginning of substantiation should always be maintaining acquisition and disposition information contemporaneously with the transaction. In practice, every event between acquisition and disposition should be traceable and intelligible to an IRS exam team. Questions that tend to matter in exams include what software was used to create original records; whether that software still functions; whether its reports are comparable to reports generated from earlier software or earlier software versions; and whether there is an explanation for discrepancies in how records are kept. Wallet-tracking algorithms are frequently updated, and the same request can generate different information as an algorithm is refined. Keeping records of the original search parameters can help examiners understand how information tracked by the current algorithm relates to earlier iterations.

Complete, Clear and Consistent - The IRS will likely seek to confirm details supporting claimed gains and losses, including price, wallet and broker information, transfer timing, and agreements governing crypto uses (including debt agreements). Each element of how crypto is held or used should be considered when maintaining records within and between wallets and other crypto holdings. Better records provide more points of confirmation for reliability. Transaction reporting provides varying degrees of usefulness, with older records sometimes limited by less sophisticated approaches to tracking digital assets. Making them logical and complete is essential for reliability and efficiency.

Consistent with what the IRS already knows—A key documentation development is the IRS’s increasing access to third-party and publicly available information. Brokerages that began issuing Forms 1099-DA for transactions beginning January 1, 2025 are providing exam teams with transaction information for document requests and potential adjustments.⁸ It’s best to assume transactions may be subject to reporting, confirming that Forms 1099-DA are accurate, and requesting corrections timely and in writing. As the IRS learns from early form-matching exercises, exam teams may ask more sophisticated questions about how crypto is used within financial portfolios. The IRS also can use public sources (e.g. press releases, filings, social media posts, etc.) to identify potential crypto transactions and relevant information; IRS training materials already reference resources such as CoinMarketCap.com to establish token market values, for example.⁹

As with any IRS exam, the opening conference is an opportunity to proactively set the tone, expectations, and working relationship with the IRS exam team. The exam team focusing on cryptocurrency likely has relevant experience or support personnel with direct crypto experience. They will have access to Forms 1099-DA, allowing them to review some information prior to meeting. It is also possible that certain transaction types or business applications are new to the exam team and time spent educating them could be productive to establishing a positive rapport. Seek to understand what crypto issues they have already identified and explain what records were maintained and, if applicable, why they may differ from records pulled prior to the exam. Providing context on how cryptocurrencies are held and used generally supports more efficient discussions later.

When discussing draft IDRs with the exam team, keep in mind the practical realities of the available records and resources. Are transaction reports complete and intelligible? Are contemporaneous reports consistent with reports generated now? Is the request focused on material items? How much work and time will be required to explain a given record? Be clear and provide context when addressing whether requested deadlines are reasonable.