Discover how to optimize your mining business structure to minimize tax liability.
Cryptocurrency mining is a complex business – even more so from a tax perspective.
Cryptocurrency miners are usually aware of the fact that they must declare income like everyone else.
The IRS provides a special form for this purpose – the IRS 8949 Cryptocurrency tax form. However, not all cryptocurrency miners know that they can deduct certain business expenses and reduce their tax liability when filling out this form.
Tax Regulations for Cryptocurrency Miners: An Overview
The IRS published guidance on cryptocurrency taxation in Rev. Rul. 2019-24 and made an additional FAQ available to the public. The IRS may update its rules at any time, so it’s important for miners to stay informed about tax law changes when they occur.
The IRS invests considerable resources to enforce tax evasion laws, and many auditors have their sights squarely set on the cryptocurrency space. Miners need to pay close attention to their tax liabilities, reporting expectations, and the tax implications of selling mined cryptocurrency. At the same time, there are certain deductions cryptocurrency miners can and should make when declaring their taxes.
Whenever you successfully mine cryptocurrency, you trigger a taxable event based on the value of the currency mined at the time of minting. When you report your taxes, you must add the market value of the cryptocurrency you mined to the rest of your taxable income for the year. Depending on how much income you make, your tax liability may range from 10% to 37%.
How to Report Cryptocurrency Mining Taxes
Under normal, non-crypto conditions, you would either receive a W-2 form from your employer reporting gross income earned or a 1099 form reporting earnings as an independent contractor. However, none of this makes any sense for cryptocurrency miners because there is no employer reporting income, and most mining businesses do not issue 1099 forms.
There are generally two ways to report cryptocurrency income. When you file your taxes, you must choose whether you are mining cryptocurrency as a hobby or as a business.
If you mine cryptocurrency as a hobby, you can report your income on Form 1040 Schedule 1 as “other income.” Since 2018, you can no longer deduct any hobby-related expenses from your tax obligations.
If you mine cryptocurrency as a business, you will need to report income on Form 1040 Schedule C. This allows you to fully deduct expenses associated with mining, which would be substantial. However, keep in mind that you must be able to provide evidence of those expenses.
Many of the things you purchase to run and maintain your cryptocurrency mining operation are eligible for deduction under Schedule C, including:
- Electricity. Cryptocurrency mining rigs can use a lot of electricity. If you incorporate your mining endeavor as a business, you can deduct the cost of electricity as an expense. Be aware that you must be able to demonstrate that the electricity was used for mining operations.
- Equipment. Your mining equipment is subject to deduction through Section 179 of the revenue code. If the value of your mining equipment in 2021 exceeds $2.6 million (with a deduction of more than $1.05 million), you may instead need to deduct yearly depreciation of the assets according to the modified accelerated cost recovery system (MACRS).
- Maintenance. If you have to repair mining equipment, replace components, or perform other services to maintain mining operations, you can deduct those costs as well. This also includes calling third-party service providers to repair Internet devices, air conditioning units, and other items.
- Space. If you rent or purchase a separate space for your cryptocurrency mining operation, you can deduct the corresponding cost from your tax liabilities. This also makes it easy to separate your electrical bill as a deduction, as you can deduct the utility costs of the location you rented or bought.
Cryptocurrency Transactions Are Taxed Separately
Minting a new cryptocurrency token is a taxable event. Selling a cryptocurrency token for profit is a separate taxable event. The former is considered income, while the latter is considered a capital gain. This might seem confusing, but it’s easy enough to demonstrate through an example:
- If you mine a single Bitcoin, you must declare the value of that bitcoin as ordinary income. If you later sell that Bitcoin for 10% more than its original value, you must report the difference as capital gains.
- Capital gains can be taxed differently than ordinary income, depending on whether you held the underlying asset for at least one year.
- Short-term capital gains are taxed at the same rate as ordinary income. That means anywhere between 10% and 37%, depending on how much income you report and your filing status. If you mine a Bitcoin and sell it 364 days later, you must declare it as a short-term capital gain.
- Long-term capital gains are taxed at a lower rate between 0% and 20%. If you hold a single Bitcoin for 366 days and then sell it, you can apply the lower long-term capital gains tax rate.
Remember, the tokens you mine are already taxed as ordinary income. The top long-term capital gains tax rate only applies to the profits you earn selling assets that have appreciated in value over more than a year. That’s the difference between the price of the cryptocurrency when you mined it and the price you eventually sold it at – not the value of the entire underlying asset.
Don’t Forget: Tax-Loss Harvesting Can Reduce Liability
Capital losses have the opposite effect to capital gains. If you sell cryptocurrency assets at a loss, you can offset your gains by the same amount. If your cryptocurrency mining business is successful enough to put you in a high tax bracket, you can potentially save more money by selling cryptocurrency assets at a loss, pushing your overall income into a lower tax bracket and lowering your overall tax liability.
Make sure to account for your profits and losses throughout the year when reporting your taxes, and keep in mind that US-based exchanges like Coinbase report to the IRS. When in doubt, play it by the book and report your mining income appropriately.