What is Crypto Mining?

How is it Taxed?

Crypto mining is a process in which a machine performs certain tasks to obtain a little bit of crypto currency. Imagine that you have a machine that mines crypto coins. We’ll talk about the specific types of machines later on in the tutorial, but for example’s sake, let’s just say that it’s your own, personal computer and you’re trying to figure out how to mine crypto currency.

Your PC would perform specific tasks that are required to be able to obtain even the slightest amounts of crypto currency. These tasks are called “Proof of Work”, and they are designed to create a fair playing field for all the different miners out there.

The tasks themselves are math equations. The more miners want to mine one, a specific mining pool - the tougher the equations become. This brings balance to the pool, but it also motivates bigger and stronger machinery usage.

Many more subtle factors come into play while the mining process is happening, but the general idea is that if your device contributes to the “mining”, you’ll get a share of the spoils.

4 General Types of Crypto Currency Mining

There are four general types of crypto mining 1) cloud mining 2) CPU mining 3) GPU mining and 4) ASIC mining.

Method #1 - Cloud Mining

Cloud mining is probably the most popular way to mine crypto currencies without having to lift a finger.  Typically, you pay someone (most often it’s a big corporation) a specific amount of money and “rent out” their mining machine called a “rig”, and the process of mining itself.

This rent lasts for an agreed-upon period, through which all of the earnings that the rig makes (minus the electricity and maintenance costs) are transferred to your crypto currency wallet.

The people (companies) that offer these cloud mining services usually have huge mining facilities with multiple farms (tens or hundreds of rigs stacked and operating together) at their disposal and know perfectly well how to mine crypto currency.

Cloud mining has become so popular mainly because it offers the possibility to participate in the world of crypto currencies for people who might not have enough money to buy their rigs or who perhaps simply aren’t interested in owning a rig.

There are two options of cloud mining - free and paid. Naturally, a lot of people that are looking for ways to mine crypto currency would gravitate towards the “free” options, but it does have its drawbacks (very slow mining speeds, extra conditions, etc.). Paid cloud mining usually works like this:

You find a cloud mining host online. You check out the plans that the host offers - there are usually four or five of these plans, ranging from the cheapest to the most expensive one; some hosts even offer you the ability to create and customize your cloud mining plan.

Once you know what you want, you simply perform the transaction (meaning that you pay the host), register your crypto currency wallet code and that is how you make the first steps on how to mine crypto currency!

Method #2 - CPU Mining

CPU mining utilizes processors to mine crypto currencies. It used to be a viable option back in the day, but currently, fewer and fewer people choose this method how to mine crypto currency daily.

There are a couple of reasons, CPU mining is EXTREMELY slow. You could go on for months without noticing the smallest amount of revenue.

It’s also usually not worth it - you make very little amounts of money, but you probably spend ten times that amount on electricity and cooling. The problem mitigates itself by a bit if you can find a place that has nice cooling and cheap electricity bills, but that’s rarely the case.

So why do people still even use CPU mining, then?

Well, basically because anyone with a desktop computer could do it.

All you need to be able to mine using the CPU method is just a computer and a couple of programs. It is possible to do it with a laptop, but it is VERY STRONGLY NOT ADVISED. Your laptop will probably fry and overheat in a matter of a couple of hours.

The fact that it’s so easy to start crypto currency mining attracts new CPU miners every day. Some people that are looking for how to mine crypto currency don’t care about the details - they just want to start the process as soon as possible, and in any way possible.

Method #3 - GPU Mining

GPU mining is probably the most popular and well-known method of mining crypto currencies. Cloud miners use GPU rigs for their services.

GPU mining is very popular because it’s both efficient and relatively cheap. Don’t get me wrong, the construction of the rig itself tends to be costly - but when it comes to its hash speed and the general workforce, the GPU mining rig is great.

GPU rigs utilize graphics cards to mine crypto currencies. One standard rig is made out of a processor, a motherboard, cooling, rig frame and - of course - a few (2 - 8) graphics cards.

Method #4 - ASIC Mining

ASIC mining (Application-Specific Integrated Circuits) are special devices that are designed explicitly to perform a single task, which in this case is crypto mining.

ASICs are very well known and treasured because they produce insane amounts of crypto currency when compared to its competitors' GPU and CPU.

But if they are so good, why didn’t I mention them sooner?

Well, mostly because they are a big subject of controversy.

You see, when the ASIC company announced its new version of the machine, the announcement caused an uproar in the crypto currency community. Many people have called for an outright ban on these machines. Why?

Because ASICS are so powerful, they rob other miners who are using GPU or CPU rigs of the possibility to keep up both in hash speeds and in earnings. Also, ASICs have twisted the economy of certain specific crypto currencies - imagine if the majority of earnings would go to one miner with an ASIC farm, what kind of chaos that would ensue.

The Best Method to Mine Crypto Currency

Now that you have an understanding of how to mine crypto currency and about all of the different ways to do it, which one is the best way?

The method that suits you the most depends solemnly on a few key details: are you willing to spend some initial money? If so, how much? Do you want to OWN a rig? Do you even want to do it with a rig?

These and many more similar questions will determine your best method for mining crypto currency.

Generally speaking, GPU and cloud mining seems to be the two big options that people love. CPU mining is slow and tedious, while ASIC mining could get very unpredictable, especially as of late.

If you want to build your rig, then GPU is the way to go. If you don’t want to spend a dime and just get going ASAP, you could give CPU mining a shot. However, if you’re willing to risk it and you’re not afraid of controversy - ASICs are a great bet. And finally, if you don’t want anything to do with neither rigs nor any other type of machinery - cloud mining is your best bet on how to mine crypto currency!

Which Crypto Currency to Mine?

Your choice of gear should also depend on the type of crypto currency mining that you've decided to do.

Some of the obvious favorites would be Bitcoin, Ethereum or Dash. Keep in mind, though, that Bitcoin mining is probably the trickiest of them all - since the coin is so popular, there are many miners around the world tuning into the few pools that there are and trying to snatch at least a small bit of Bitcoin. This might result in you waiting for countless hours until the first drops of Bitcoin start coming in.

Keeping that in mind, your best bet would probably be to stick with Ethereum or some other less-popular crypto currency. Depending on your method of choice, check out the prices, calculate when your return on investment would happen, do some math and you’ll figure it out in no time!

How is Crypto Mining Taxed?

On October 9, 2019 the IRS released long awaited guidance on the taxation of crypto currency through Rev. Rul. 2019-24 and an FAQ. The IRS guidance brought crypto currency in even more alignment with the tax rules on equities. With increased enforcement on crypto currency tax evasion, proper reporting is more important than ever. Specifically, miners need to be aware of; 1) the tax implications of mining crypto; 2) the tax implications of selling or trading mined crypto; and 3) available mining deductions.

Crypto miners may choose to treat their activities as a hobby or a business. While it may seem simpler to treat it as a hobby, mining as a business has more deductions and benefits and may reduce your overall tax liability. The key is determining if the added complexity of a business is worth the tax savings.

The difference between a hobby and business depends on subjective factors like:

The time and effort spent.

Your intent to make a profit.

Your dependence on mining income.

Your mining profitability.

Mining as a Hobby

Hobby income is treated as ordinary income by the IRS, which means that it’s taxed at your marginal tax rate. These tax rates depend on your overall level of taxable income. There are only a handful of deductions that you may be able to take for a hobby business, so most of that income is directly taxable.

Mining as a Business

Business income is treated separate from ordinary income (e.g. income from wages or investments). The biggest advantage of setting up a business is that you can deduct many more expenses, although expenses like computing resources and office space must be used exclusively for crypto mining in order to qualify as a deduction.

The high level process for calculating business income is:

Calculate your revenue by taking the amount mined each day, multiplying it by the trading price on a reputable exchange and summing up revenue for the year.

Calculate your variable expenses by summing your additional electricity bills, server rental costs and any other variable costs involved with crypto mining.

Calculate your fixed expenses by listing your qualifying business expenses, such as server hardware, and depreciating it over time.

Subtract the revenue from the expenses to come up with the net income. This figure is reported on your corporate tax return or on Form 1040 Schedule C.

1. The Tax Implications of Mining Crypto currency

Pursuant to IRS Notice 2014-21, when a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income. This means that successfully mining crypto currency creates a taxable event and the value of the mined coins must be included in the taxpayer’s gross income at the time it is received.

Typically, taxpayer’s receive a W-2 from their employer or a 1099 if they were an independent contractor that reports the gross income they received. Mining is a unique situation because there is no employer to issue a W-2 reporting on gross income or a vendor to issue a 1099. Furthermore, most mining companies are also not issuing 1099’s reporting the income received. Mining is a self-employment income activity and must be voluntarily reported in order to avoid hefty fines for unreported income and audits.

2. Available Mining Deductions

If you mine crypto currency as a trade or business, then you may be eligible for certain deductions to lessen your tax liability. § 162 of the Internal Revenue Code states “[t]here shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” Miners may deduct certain expenses from their mining income.

Some estimates place the annualized global mining revenues at ~$5.6 billion and global mining expenses at $3.6 billion. These statistics show that expenses may account for greater than 50% of the income received from mining. Some frequent expenses that may be eligible for the trade or business expense deduction include mining equipment; electricity costs; repairs; and rented space used to operate the equipment.

Equipment

Miners may deduct the cost of their mining equipment from their ordinary mining income. If the mining equipment exceeds $1 million in costs the taxpayer may need to use the modified accelerated cost recovery system (MACRS) to determine how to depreciate the equipment for tax purposes.

Electricity Costs

The largest cost to mining crypto currency is the price of electricity. The energy used worldwide to mine crypto currency is equivalent to the energy consumption of the country of Australia. Electricity costs are an expense that if properly documented may be eligible for the trade or business deduction. To properly document your electricity costs, you should track the amount of electricity that is used solely for mining. If you are mining from your residence, then you will need to track and allocate the amount that is attributable to mining. It is important to track the electricity costs from mining because you may only deduct business expenses are not eligible to deduct the electricity costs that you used for your residence.

Repairs

If your mining equipment needed repairs during the year, then this expense may be eligible for the trade or business deduction. You should save receipts to validate the expenses in the event of an audit.

Rented Space

If you rent a space to hold and run your mining equipment, then you may be eligible to deduct the rental costs as an expense. If your mining equipment is located at your residence, then this will be treated similar to a home office and may be more difficult to deduct the expenses. See the rules applicable to the home office deduction to see if you are eligible to deduct costs for the business use of your home.

The IRS largely classifies mining income as self-employment income; therefore, taxpayers may be responsible for self-employment taxes on mined income.

3. The Tax Implications of Selling Mined Crypto currency

Selling mined crypto currency creates a second taxable event. The value of the crypto currency at the time it was mined (the amount included as ordinary income) becomes a taxpayer’s cost basis in the capital asset. When a taxpayer sells mined crypto then the amount received will be reported as proceeds and will be offset against the miner’s cost basis in the asset. If the value of the crypto is higher at the time of the sale, then the taxpayer has a capital gain. If the value is lower than the taxpayer will have a capital loss. Every sale or trade of mined crypto must be reported on an IRS 8949 crypto currency tax form.

Conclusion

Mining

There are many different ways on how to mine crypto currency. These are simply the main methods.

One thing that you should not only remember, but also do right away is to create a crypto currency wallet. Decide on the type of crypto currency that you want to mine and simply look up the wallet options for that currency. I strongly recommended Ledger Nano S, Coinbase and Trezor, they're truly reliable.

You’ll have no problems finding one for coins like Bitcoin, Ethereum or Litecoin, but if you want to mine the less-known currencies, then you might need to search for a bit until you find a reputable wallet.

Getting a secure and reputable wallet is the most important task when you’re starting with crypto currency mining. Imagine if you’d be mining for a year and all of your savings would be stolen only because you didn’t pay enough attention while choosing the wallet and picked a fishy one that got hacked into.

If you’re serious and are looking for ways on how to mine crypto currency, I would suggest buying a hardware wallet - they are the safest and most trustworthy cryptocurrency wallets out there.

Taxation

The IRS aggressively enforces tax reporting on mining and selling crypto currency. Fortunately, miners may be eligible for certain deductions to lessen their tax liability.

Remember - the method that suits you the most will depend solemnly on what you want and what kind of resources you have, so choose carefully!

The important thing to remember about the taxation of crypto mining and crypto currency in general, it is still a relatively new industry.  It is the taxpayer’s responsibility to be on the right side of the law and it is often difficult to understand what that is.  There is much conflicting information out there.  Contrary to some opinions, the mining of crypto and the sale of crypto currency is taxable!

If you do decide on giving mining a chance, I wish you the best of luck!