Sometimes in trying to decide something I might imagine a more extreme case, and see what it tells me...
If several sessions were run, with leveling up and all as expected, and then you said, "Hey, remember that soothsayer back in the first session? He actually put you all to sleep and everything we've been doing is a dream. You are all first level characters", people would likely be upset.
If they are playing the dream just as they would play anything else, why not give them XP? If you need a narrative explanation to justify it, maybe they gained insight (into the world, into themselves, etc.) that will help them from there forward.
Gnome Boy (a.k.a. "Jon") • DCC play-tester @ DDC 35, Feb 2011. • Beta DL 2111, 7:00 AM PT, 8 June 11.Playing RPGs since 1977
• Quasi-occasional member of the Legion of 8th-Level Fighters.—Here Be DCC Monsters—VOORAK, L, Hunter, S10, A12, Sm10, P6, I13, L13, AC 10, HP 3, Spear +0 1d8, Init 0; R 0, F 0, W -1, Holy water, Pelt, 3 iron spikes, 1d ration, 4-leaf clover (Find secret doors) (+1), Com +1
SARKLA, C, Gatherer, S9, A14, Sm14, P15, I14, L8, AC 11, HP 4, Knife +0 1d4, Init 1, R 1, F 1, W 1, Chest, Basket of veggies, 2d ration, lg sack, waterskin, torch, Seventh son (Spell checks), Com +1
TARR, C, Hunter, S14, A11, Sm15, P13, I7, L7, AC 10, HP 3, Spear +1 1d8+1, Init 0, R 0, F 1, W 1, Holy water, Pelt, 4 torch, flint/steel, 1d ration, sm sack, Fox's cunning (traps), Com
TELVA, N, Herbalist, S13, A6, Sm9, P6, I12, L10, AC 9, HP 2, Club +1 1d4+1, Init -1, R -1, F 0, W -1, Chain 10', Herbs- 1 lb., 50' rope, 2d ration, torch, Speed of cobra (Init), Com