The ‘Phantom Gain’ Trap
The Internal Revenue Service (IRS)’s new Form 1099-DA, though well-intentioned, could unfairly target many cryptocurrency users for audits due to incomplete or inaccurate cost basis reporting by exchanges. According to Nick Slettengren, founder of Count On Sheep and a former crypto trader, the problem stems from a fundamental disconnect in the digital asset ecosystem.
While Form 1099-DA is designed to mirror traditional Form 1099-B used for stock trades, the underlying data infrastructure in crypto is far more fragmented. Slettengren argues that many exchanges lack complete information on users’ digital assets; therefore, they are ill-equipped to accurately compute their tax obligations.
“Many exchanges do not have visibility into the full lifecycle of a user’s assets — especially when assets are moved between platforms,” Slettengren explains. “As a result, they often report sales with missing or $0 cost basis, artificially inflating taxable gains.”
To illustrate, Slettengren uses an imaginary scenario in which an investor buys bitcoin on Exchange A, transfers it to Exchange B, and later sells it there. According to Slettengren, Exchange A might treat the transfer out as a taxable event or simply have no record of its acquisition cost. Exchange B, on the other hand, might report the transaction with a $0 cost basis because it has no record of the initial purchase price.
In this instance, the IRS will receive a Form 1099-DA from Exchange B showing the full sale amount as a taxable gain, even if the investor made little to no actual profit. This discrepancy creates what Slettengren terms “phantom gains,” immediately raising red flags with the IRS and potentially triggering an audit.
Inter-Exchange Data Gaps Exacerbate the Problem
Adding to the challenge is the absence of any mandate requiring exchanges to share cost basis information with each other. Slettengren highlights a common scenario: “If a user transfers crypto from Exchange A to Exchange B — a common behavior among traders — Exchange A may treat it as a sale and report it as such, while Exchange B reports the incoming assets with a $0 cost basis.”
This means the IRS’s automated systems could see a “sale” from one platform and a seemingly new asset with no acquisition history on another. This fragmented reporting creates a potential compliance disaster, leaving taxpayers vulnerable to overpaying on taxes or facing an audit for perceived underreporting, simply due to the limitations of current exchange reporting capabilities.
Given these systemic challenges, Slettengren stresses that individual cryptocurrency users cannot solely rely on exchange-provided tax forms for compliance. Without diligent personal record-keeping and proper reconciliation of transactions across all wallets and platforms, taxpayers risk significant financial penalties and the stress of IRS scrutiny.
“This is why professional crypto tax support is essential,” Slettengren advises. “To reconstruct accurate cost basis, apply the right tax strategies, and ensure full IRS compliance under the new rules.”
The Count On Sheep founder also warns crypto users against being overly reliant on legacy tax software or traditional CPAs, as they may expose them to compliance risks, missed savings, and potential audits. Instead, Slettengren recommends hiring so-called blockchain accountants, whom he says “understand the nuances of digital asset activity and can provide forensic-level reconciliation.”
Strategies for High-Net-Worth Individuals
Meanwhile, Slettengren shared tips for high-net-worth individuals (HNWI) that enable them to minimize their tax exposure while remaining compliant.
“One of the most effective strategies is tax loss harvesting — selling poor-performing or underwater coins to realize capital losses that can offset gains elsewhere in the portfolio. This is especially useful in volatile markets and can be applied annually to reduce taxable income or carried forward to future years,” the founder explains.
Slettengren also recommends cost basis modeling, such as the Specific Identification (Spec-ID) method, which allows users to select which specific lots of a crypto asset they are selling. This, according to Slettengren, enables them “to choose the ones with the most favorable tax implications — whether to realize a loss or minimize a gain.”
However, the Count On Sheep founder says users to be mindful of recent IRS guidance, which imposes additional requirements for using Spec-ID.
“Under recent IRS guidance, using Spec-ID now requires additional documentation: investors must identify the specific coins or lots they are selling at the time of the transaction, and in some cases, must notify the exchange in advance to qualify for this treatment,” Slettengren warns.
