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What to Expect from a Crypto Tax Audit
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Many tax agencies are increasing their scrutiny of crypto tax returns.
Most crypto tax filers will not be audited, but some will.
The best way to prepare for possibility of a crypto tax audit is to keep thorough records of all crypto transactions and any related communications.
How common are crypto tax audits?
Most crypto investors who make a good-faith effort to report their crypto taxes will never face a crypto tax audit. However, tax and regulatory agencies around the world are turning their attention to crypto as an underreported source of income, so it's not unreasonable to expect there may be a rise in crypto tax investigations on the horizon.
If you receive an audit request, don't panic. While the audit letter may have many questions, requests for transaction histories, and a quick two-week deadline, you likely have all the information available in your crypto tax software accounts.
The IRS generally audits up to six years back, so you should store your records for that long or longer, either in a crypto tax calculator or your own files. When responding to the IRS, the best practice is to answer each request transparently and in an organized manner.
Common IRS audit questions
While audit requests can vary in content, there are a few typical preliminary questions the IRS will ask about your crypto taxes. When responding to the IRS, the best practice is to answer each request transparently and in an organized manner.
You can expect that they will ask you to disclose all of your accounts, including:
“All wallet IDs and blockchain addresses owned or controlled by taxpayer.”
“All digital currency exchanges (DCE) and peer-to-peer (P2P) facilitators (e.g., Coinbase, Paxful or Localbitcoins.com) (foreign and domestic) ... with associated user IDs, email addresses, IP addresses, and account numbers relating to those platforms.”
As outlined in record-keeping IRS notice response (Q&A 45), the IRS also requires the following records for every transaction:
“The date and time each unit of virtual currency was acquired,”
“The basis and FMV of each unit at time of acquisition,”
“The date and time each unit was sold, exchanged, or otherwise disposed of,”
“The FMV of each unit at the time of sale, exchange, or disposition, and the amount of money or the FMV of property received for each unit.”
“Explanation of the method used to compute basis relating to the sale or other disposition of virtual currency.” (Note that this refers to the crypto accounting method).
We have from time to time seen other, more expansive questions, which is another reason to keep very thorough records of your crypto transactions. For instance, some audit letters have asked for “all correspondence (e.g., emails, texts, tweets, etc.) with all counterparties to any virtual transactions.”
Be aware that after you submit your first response, the IRS may request follow-up information based on your responses.
Common CRA audit questions
The Canada Revenue Authority also audits crypto traders. To begin its process, it sends a 54-question survey asking about a taxpayer's trading history. Some example questions include:
When did you start getting involved in the cryptocurrency space, and how did you get involved?
Do you use Shapeshift exchange or Changelly? If so, please provide us with the cryptocurrency addresses you’ve used to trade with, along with the dates you made these particular “swap” trades.
Who filed the crypto tax returns for the period under audit? Also, what crypto tax documents were given to the tax preparer with regards to your cryptocurrency investments in order for them to calculate the right capital gain(s) and/or income?
Can you tell us about all the cryptocurrencies that you own? Provide us with a timeline of when you made each purchase from fiat to crypto.
Click to view the full CRA questionnaire.
When asked about the increased audits, the CRA released this statement:
“This unit has enhanced the CRA’s ability to monitor and enforce compliance in areas of emerging risk, including the cryptocurrency space. There are currently over 60 active audits related to cryptocurrency. The CRA is also committed to helping taxpayers understand their tax obligations when using digital currencies, and to remind them that using digital currency does not exempt consumers from their tax obligations. The CRA has published educational material on its website regarding the tax treatment of dealing in Digital Currency.”
How to get through a crypto tax audit
The easiest way to prepare for any potential audit is to purchase crypto tax software with audit support, like our VIP crypto tax plan. You can leverage our audit experience to help you respond quickly to the IRS instead of trying to put together materials on your own.
The TokenTax dashboard also conveniently stores all your information from previous years so that you can easily share any past tax year with the IRS. All of these features are reasons to choose TokenTax to manage your crypto taxes.
For the more complex audit questions, you need to be able to show proof that your crypto tax calculations track all cost bases for your crypto audit trail. Having a crypto CPA on hand will help you respond with details about your crypto lending and margin trading. It will help immensely to have crypto tax experts who have successfully guided individuals through audits before.
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