The Electoral Commission also warned the party could face penalties unless it overhauls its fundraising system to ensure all donations above £500 come from the UK, as required by the law.
The watchdog visited the party’s offices last month to probe concerns about the source of its donations because they are paid online through PayPal, which does not track whether the cash is coming from abroad.
Ex-PM Gordon Brown was among several critics who questioned whether the party was receiving donations from Russia or the US, where Farage has close links with Donald Trump and the so-called “alt-right”.
Following the visit, the commission has now concluded that “the fundraising structure adopted by the party leaves it open to a high and on-going risk of receiving and accepting impermissible donations”.
It also warned that the party could face further action if it does not accept recommendations to overhaul its fundraising system.
Farage’s party has returned one £1,000 donation as it could not identify whether it was from a legal source.
Louise Edwards, director of regulation at the Electoral Commission, said: “It is legitimate for any political party or campaigner to adopt a fundraising strategy that focuses on raising small sums.
“Our visit to the Brexit Party has enabled us to make specific recommendations to the party that will support it to meet its legal responsibilities when it comes to receiving funds.
“Should it fail to meet those responsibilities, this will be considered in line with our enforcement policy.”
Farage became embroiled in a war of words with the watchdog after accusing it of being “absolutely full of Remainers”, to which the commission replied insisting it was independent and impartial.
The watchdog urges parties to check every payment that they receive online to make sure they are legal and request as much information as possible from potential donors to ensure they are compliant with the rules.
In a statement, the Brexit Party said the commission had confirmed its method of fundraising was legitimate and had been adopted by other political parties and campaigners.
“They haven’t found any examples of infringement of Electoral Commission rules,” it said.
“However, we are grateful that they have made some helpful suggestions to reduce future risk as we fundraise and we will be working to embrace those recommendations as soon as practicable and possible and in the time frame set out.
“We trust that the Electoral Commission have been applying the same oversight and rigour to the other political parties and their fund-raising.”