Tax Planning for Cryptocurrency Miners and Stakers

In the last 20 years, cryptocurrency has opened an exciting new world of investment opportunities. Popular currencies like Bitcoin, Litecoin, and Zcash have sparked interest with promises of high earnings and rapid returns on investment. In all the excitement, it’s easy to forget that whether you run or stake a bitcoin operation, you’re incurring a tax obligation to the IRS.

Don’t panic. While the rules surrounding how cryptocurrency is taxed may seem complex, here are some basics to help you and other crypto earners avoid problems with the IRS.

What Is a Cryptocurrency Miner?

In the context of cryptocurrency, the term “mining” refers to a process in which (a) cryptocurrency transactions are verified and (b) new units of currency are created.

Often a single computer is insufficient to mine cryptocurrencies effectively. In response, investors often pool together to increase their collective power, with mining profits allocated to each member. A group of miners together can verify more transactions, without running up huge electric bills. These groups of crypto miners can become quite powerful. For example, groups like BitFury, F2Pool, and AntPool control over a fifth of crypto mining operations worldwide.

Crypto Mining as a Hobby vs. Business

If you mine cryptocurrency as a hobby, the IRS requires you to declare the value of the coins you hold as “other income” on your return (see Line 21, Form 1040, Schedule 1). Any expenses related to the mining operation are limited by the “2% rule,” which states that you may only deduct those expenses that exceed 2% of your adjusted gross income for that tax year.

If you are crypto mining as a business, however, the rules are a little different. Crypto business operators must report any income generated from crypto mining on Schedule C of your return. You may deduct any expenses related to your crypto mining operation, provided that each can be verified (keep those receipts). Any net profits made through crypto mining must also be declared as income.

If you’re unsure whether your crypto operation qualifies as a business or hobby, the IRS has some guidelines that might help. As a rule of thumb, however, if you are engaged in crypto mining for profit, you are likely to be deemed a business by the IRS.

What Crypto Mining Expenses Are Deductible?

Calculating your crypto mining tax deductions might seem like a daunting task, but if you earn a large annual income through crypto trading, you may be able to cash-in on some savings. If you mine as a business entity, you may write-off certain expenses on your return (note: this applies to business miners only). Here‘s a quick review of some common crypto mining tax deductions:

  • Electricity. Crypto mining requires a lot of electricity, so the IRS allows you to deduct the amount used for your crypto mining business. Be mindful that you may only deduct an estimate of the electricity costs used directly for mining.
  • Equipment. If you’ve invested heavily in hardware or software to conduct your mining operation, you may be able to deduct part or all of that expense in Section 179 of your return.
  • Repairs. If your equipment breaks down and the repair is costly, you may be able to claim part or all of the repair costs as a deduction. Remember to keep receipts in the event of an audit.
  • Business Space.If you pay rent or mortgage on a space used solely to conduct business, a portion of your obligation may be tax deductible. Similarly, if you work from home, you may be able to avail yourself of a deduction. Home office deductions are generally dependent on how much of your home is used for professional purposes only.
  • Business Losses. If you operate a crypto mining operation as a business and lose money, you may also declare your business losses as deductions on your return.

What Is Staking?

Another term you’ll often hear in the context of cryptocurrencies is “staking.” Staking is the name for the process of allocating cryptocurrencies to a wallet and earning interest much as one would on a savings account. As a staker, you’re validating transactions as they come through the network. Advantages of staking include low energy requirements, as well as less expensive equipment. This makes staking a great way to generate passive income without the ground-level expenses of a full-scale mining operation.

How Is Staking Taxed?

As yet, there is no specific tax guidance on staking transactions. However, IRS Notice 2014-21 states that a taxpayer who “mines” virtual currency is subject to tax on the new virtual currency received from those activities as ordinary income. It’s believed that the IRS will view staking rewards as ordinary income if the taxpayer can dispose of the new coins at the time they are generated.

To learn more about the specific tax laws governing cryptocurrency, check out our recent blog post

We hope you find this information helpful. If you mine cryptocurrency as a hobby or a business, you’ll need to keep careful records and receipts. Our skilled tax professionals can help you get your documents together, review your deductions, and ensure that you’ve filed all forms as required by the IRS.

Why go it alone? Contact Moskowitz LLP today!