Reporting your mining rewards on your tax return can feel overwhelming.
But it doesn’t have to. Below, we’ll break down everything you need to know about how cryptocurrency mining rewards are taxed. We’ll also take a look at a simple strategy to help you easily keep track of your cryptocurrency for tax purposes.
This is a guest post from our friends at CoinLedger.
How are cryptocurrency mining rewards taxed?
Cryptocurrency—including cryptocurrency mining rewards—is treated as property by the IRS and most tax agencies around the world. That means your cryptocurrency is subject to ordinary income and capital gains tax.
Ordinary income tax: When you earn cryptocurrency, you’ll recognize ordinary income based on the fair market value of your crypto at the time of receipt.
Capital gains tax: When you dispose of your cryptocurrency, you’ll incur a capital gain or loss depending on how the value of your crypto has changed since you originally received it.
Cryptocurrency mining rewards are taxed similarly to other crypto-assets.
When you earn rewards from cryptocurrency mining, you’ll pay income tax based on the fair market value of your crypto at the time of receipt.
When you dispose of your rewards from cryptocurrency mining, you’ll incur a capital gain or loss depending on how the price of your crypto has changed since you originally received it.
While you may pay income and capital gains tax separately on your cryptocurrency mining rewards, it’s important to remember that you aren’t technically taxed twice on the same profits. Your capital gains are only taxed based on how the price of your crypto has changed since you originally received it.
To better understand how this works, let’s take a look at an example.
Henry earns $10,000 of BTC through mining.
Later, he sells his BTC for $12,000.
Henry recognizes $10,000 of ordinary income and $2,000 of capital gain.
Business or hobby?
The IRS uses multiple factors to determine whether your mining operation should be treated as a business or a hobby for tax purposes. These include:
- The time and effort you put into your mining operation
- Whether you run your operation in a ‘businesslike manner’ (e.g. keeping detailed books and records detailing profits and expenses)
- How much you depend on the income from your mining operation.
- How much profit you make
You do not need to have a business entity set up for your mining operation to meet the criteria. As long as you meet the IRS criteria for being considered a business, your operation will be taxed as a business.
The line between business and hobby mining can get fuzzy at times. If you’re not sure which category your mining operation falls into, you should reach out to your tax professional.
Business tax advantages
If your operation is considered a business by the IRS, you can save money on your taxes by deducting relevant expenses.
While hobby miners cannot deduct relevant expenses from their taxes, mining businesses can claim expenses like the cost of equipment and the cost of electricity.
It’s important to remember that having your mining operation taxed as a business may lead to a higher tax liability in some situations. If you’re operating a business as a sole proprietor, you’re subject to an additional self-employment tax of 15.3%.
Starting a business
Some miners choose to set up a business entity for their mining operation.
It’s important to note that there isn’t necessarily a tax advantage to setting up a business entity structure. As stated earlier, your mining operation will be taxed as a business as long as you meet the IRS criteria. However, an entity structure comes with other advantages.
Protecting owners from liability: In an LLC, owners are not personally liable for specific business debts and business-related liabilities.
Setting up a legally binding operating agreement: If your mining operation has multiple owners, an operating agreement will clearly lay out details such as how profits are allocated to owners.
Remember, a business entity comes with significant ongoing and upfront costs. If you’re considering setting up a business entity for your mining operation, you should speak with a tax professional about your specific situation.
Tracking crypto taxes
To report your mining rewards and other cryptocurrency transactions on your tax return, you’ll need to keep track of the following information.
- The type of cryptocurrency you are mining
- The amount of cryptocurrency received/disposed of in each transaction
- The date you received your crypto
- The date you disposed of your crypto
- Fair market value of your crypto when you received it (in USD)
- Fair market value of crypto when you disposed of it (in USD)
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