So you have your mining rigs set up at home. They are actively hashing away and accumulating you a nice stash of cryptocurrency.
However, there is one thing you need to consider… and that is taxation
More particularly, how do you deal with the tax implications of profits made from mining a digital asset? How do you structure your tax bill and make it more efficient?
In this post we will take a look at general tax implications for cryptocurrency miners. While the specific tax law will be that of the IRS, many of the same principles could be laid out in your home country.
How The Tax Man Views Crypto
Before we can take a look at how your home crypto mining operation can be taxed, we first have to go through the general tax implications of cryptocurrencies and the capital appreciation on them.
As you may know, the IRS created a broad framework for cryptocurrencies back in 2014. The particular directive was that of the Notice 2014-21, Q-9 which dealt with how the IRS would apply the existing tax code to the new realm of digital currencies.
For the purposes of taxation, cryptocurrecies can be viewed as property. Hence, if you earn cryptocurrency from any endeavour then the earnings are subject to income tax. If the cryptocurrency were to appreciate in value then it would be subject to capital gains tax.
If you are mining cryptocurrency at home then you will be subject to the income tax on these particular earnings.
The “Taxable Event”
If you have had to previously deal with cryptocurrency taxation in the realm of trading then you will have come across the concept of the “taxable event”. For example, when you sell your cryptocurrency for Fiat and have made a gain that has triggered a taxable event.
So how does this work for mining?
Well, quite simply the taxable event for income derived from mining is when the actual coins will hit the blockchain. The amount that will be stipulated for those earnings is the price that the cryptocurrency was worth the moment that it appeared on the blockchain.
This is also the price that will be used as the benchmark to calculate the capital gains or losses for tax purposes as we move forward. The IRS has actually included a helpful example of this:
[A]ssume you mine 1 bitcoin in 2013. On the day it was mined, the market price of bitcoin was $1,000. You have $1,000 of taxable income in 2013. Going forward, your basis in the bitcoin is $1,000. If you later sell the bitcoin for $1,200, you have a taxable gain of $1,200 – $1,000 = $200
In terms of the price that is applied in above example, the general tax definition of it is the “fair-market” price. This is more loosely defined as the price that the cryptocurrency will fetch on the open market if it were converted into a fiat currency.
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Of course, this is itself not so straightforward. Anyone who knows how volatile and illiquid some cryptocurrencies are can appreciate the difficulty in assigning an exact price. Which cryptocurrency exchange price are they referring to? Is it an End of Day price or the price at the exact moment that corresponds to the block timestamp?
These are the more in-depth questions that we hope the IRS will iron out in further directives.
Hobby Or Business
Whether you are running your mining operation as a hobby or as a business will have important impacts on your taxation. This is because it will define whether you are earning the cryptocurrency as a wage or as self-employment.
If you claim that your mining operation is a hobby then the earnings that you get from mining will be classed as “wages”. When your income is classed as a wage it means that you will only pay half of the self-employment tax.
However, if you are claiming that your mining activities are a business then you will have to pay the full self-employment tax. As of the 2018 tax year, the self-employment tax rate stood at 15%. While this sounds less optimal in theory, running your operations as a business means that you will have more options for itemised deductions.
In order for you to claim that your mining operation is a business, it has to meet a certain criteria in the eyes of the IRS. More specifically, it must be done in a consistent way with the express purpose of generating a profit. If it is more in an on-off manner then it is most likely a hobby.
Irrespective of whether it is a hobby or a business, you are only subject to self-employment income taxation if your mining income is greater than $400 in a particular tax year.
What About Deductions?
Of course we all know that there are significant costs that are involved in mining cryptocurrencies. Luckily for you, these expenses can be considered as a cost of doing business and are hence tax deductible.
So, what expenses can then be considered as tax deductible?
Well, the IRS tax code claims that any expenses that are necessary for the operation of the business can be deducted for tax purposes. This generally can be applied to most of your fixed and operational costs of running a mining operation which include some of the following:
- Capex on hardware and secure coin storage
- Mining Pool Fees
- Administrative Expenses
- Accounting Expenses
- Business Travel
These are broad definitions of some of the expenses that could be considered necessary for running an operation. However, a degree of prudence is also required when claiming these expenses in your tax returns.
For example, you cannot attribute your entire electricity bill to the cost of running your mining rigs. If you are mining from home then a proportion of those costs will be related to your general home use. The IRS will no doubt be aware of this and will ask for a more concrete breakdown.
You could then consider installing a separate meter that will track the electricity that was used exclusively by your mining rigs. This is probably a good investment in any event as it will allow you to monitor excessive use for performance purposes.
The same can be said for “Business Travel” above. If you are going to be attending a conference or event that is related to mining then this could be considered an expense applicable to your operation. You will need to make that judgement personally or consult your accountant.
Something that is important to note though is that the extent to which you can deduct these expenses depends on how you have classified your mining operation. If you have classified it as hobby then there are limits on the deductions that you can claim.
If your mining operation is a hobby then you can only deduct expenses that exceed 2% of your adjusted gross income. You are also not allowed to deduct losses from your mining operation from your personal income tax submission.
It is also important to note that if you are running your operation as hobby, you can only claim the deductions if you have not taken the standard deduction.
In the US, the IRS allows for a standard deduction of $6,350 per person or $12,700 for a family (as per 2017 tax year). Hence, unless your mining deductions are larger than this, it does not make sense to claim them.
If this is the case and you would still like to claim these as a hobby then you can do so in the Schedule A itemized deductions form. You can find examples of this form on the IRS website.
On the other hand, if you have classed your mining as a business then there are no limitations on the deductions. You can calculate your business expenses using schedule C of the IRS tax forms.
As with any new technology, the laws surrounding them are initially vague. Cryptocurrencies are no different and the IRS has said that you are best advised to get the help of a tax professional if you are uncertain about them.
Irrespective of how you classify your home mining, you are required to pay tax on it if the value of the coins that you generate is above $400 a year. If you were uncertain about how much cryptocurrency tax you may be liable for you can always use online bitcoin tax calculators.
You also need to fully consider when you are planning to sell your cryptocurrency for fiat. If you are selling it in less than a year then you can be subject to short term capital gains. If, however, the sale is made in more than a year it will be considered long term gains and a different rate will be applied.
You also have to think carefully about how you will classify the operation. Although labelling it as a “business” will afford you more deductions, you will have to pay the full 15% self-employment tax. Moreover, you may have to prepare quarterly tax reports for the IRS which could increase your costs.
Mining cryptocurrencies at home is no doubt a great way to make extra income. It is also one of the most effective ways to get your hands on newly minted coins to place in your cold storage.
However, Uncle Sam is no doubt aware that cryptocurrency mining is a profitable new endeavour that people have been picking up with vigour. If you earn income on your mining operation then the Taxman will want his slice of the pie.
As long as you are aware of your tax obligations and have an understanding of how to report your income and what you can deduct, there is not too much to be concerned about.
Keep hashing on!