Perhaps you have dropped a couple of thousand dollars on a new mining rig and you have it churning away, performing blockchain confirmations for Bitcoin or some other altcoin. The coins started accumulating and you began to feel like an evil super genius, laughing maniacally as thoughts of Lambos danced in your head. Then, the post-mining electric bill arrived and it all came crashing down around you as you realized that all those fans whirring 24/7 were actually consuming a significant amount of electricity and the local utility monopoly now wants their share of the take.
Suddenly, that Lambo doesn’t look quite so attainable.
Well, take heart, my friends, because I am going to share some resources to help you determine how you can profitably mine for cryptocurrencies and, more importantly, show you how you can get the IRS to help you subsidize those utility bills and the mining rig through a tax break. For a while, at least.
Picking a mining rig
To start with, an excellent resource I would recommend if you are interested in mining is www.cyrptocompare.com. They give detailed analysis on the cost of various graphics cards and mining rigs with a breakdown of the payback period for each piece of equipment, reflected based on the current prices for equipment as well as the current value of the desired coin you might wish to mine.
I will offer one word of caution. In some cases, they reflect the payback period on just the costs of a graphics card (the Nvida Geforce GTX 970 listed at $520 with an 1,836 day payback period mining Ethereum as of the publication of this column, for example) and in others, they reflect the payback period on the total cost of a mining rig (the ETH Mining Rig Ambition 1070 listed at $43,900 with a payback period of 9,112 days also mining Ethereum) so you don’t necessarily get a true apples to apples comparison in some cases.
With all of these breakdowns, there are even a few losers that currently could never sustain a profit and would only ever generate a loss. “Why list them then?” you might ask. Well, it is important to keep in mind that there are a lot of moving parts to these calculations so if one variable changes (i.e., price of the equipment drops or the price of Ethereum skyrockets), the payback period could change significantly and a processor that currently can’t turn a profit may suddenly be able to – especially if the cost of the mined coin rises. Also, there is the very real possibility that the coin you mine today will be worth far more than today’s prices in the future making the whole process worthwhile after all. Cryptocompare.com explicitly states what the values are for the estimates they are making – even the estimated kWh per hour cost of utilities. Further, if you have your own configuration and data, they have a nifty little calculator where you can plug in your own variables. I find it to be an excellent resource for anyone considering mining.
Now the fun part… Taxes
So you have made your selection and dropped some cash on your desired mining equipment. What now? Now you make the tax man help you get started by taking advantage of the various legal deductions you can take for your mining operation.
The key to taking advantage of every opportunity the IRS presents you is fairly straightforward. Treat mining like a business.
If you have never owned a business before, this can sound pretty scary, but it really isn’t. You don’t have to get a federal ID number to start. It can all flow under your social security number and be filed on what is referred to as a Schedule C. That is simply the portion of a tax return where a sole proprietor reports business income and losses. So congratulations, you are now a sole proprietor! Not quite as glamorous sounding as Lone Wanderer for all of you Fallout fans but it still has a nice ring to it.
For purposes of this scenario, I am going to use the Nvidia Geforce GTX 970 simply because that is what I am running in my rig so it is a real world scenario for me.
So based on cryptocompare.com, I will be able to mine $255.83 per year in Ethereum using my machine. Actually they reflect $103.41, which is net of the estimated electrical costs of $152.42 but let’s hold off on all of the expenses for now. If you take no deductions on the $255.83 and fall into the most common tax bracket, you will owe 25% of your mining profits in taxes. That’s about $64 bucks you would owe the IRS. But we are not going to pay any taxes on this income.
Side note: If you have read my previous columns, you may be asking, “what if I hodl and don’t sell the mined coins?” Well, again, the IRS does not currently provide clear guidance on that other than to say cryptocurrencies are property. I believe from the IRS perspective, you will be deemed to have sold the mined coins for their current market value. If you, in fact, hold them for investment, you have converted them from business income to investment property and they will take the basis for the same exact amount you reported as income. So if you mine one Ethereum which lists at $270, then you are deemed to have sold it for $270 in USD and have “earned” that amount in revenue. If, in fact, you hold it, it is as if you immediately bought it back for $270. If you then later sell it for $250, you will actually have a capital loss. See my previous column for more clarification on the impact of long-term and short-term capital gains.
So back on point, we have $255.83 in taxable business income. Now it is time to start chipping away at it.
First, let’s take the layup, $152.42 in increased utility costs as estimated by cryptocompare.com. Your costs will actually be slightly higher than that because you don’t just plug a GPU into the wall. You need all the parts and pieces, motherboard, CPU etc. Review them in part or whole to determine the estimated kWh costs and plug it into the calculators at cryptocompare.com for a better estimate. Also, document this! That will be important if the tax man ever cometh riding in on a black steed with sickle in hand to dig through your underwear drawer.
Deducting the utilities puts us at a net income of $103.41.
The next deduction is the cost of the computer itself. This is going to be your biggest expenditure. With a GTX970, it is not unreasonable to assume you will spend another $1,000 to have a suitable rig so let’s say your startup cost for that is $1,500 just to keep things clean.
You can’t actually take the full cost in the first year though. Long-lived assets have to be depreciated (expensed over multiple years). I, and probably most other conservative CPA’s, would probably call it 5-year property but I could almost argue that with the rapid changes in technology and the fierce competition out there for mining, it might have a useful life of only 3 years. For this example, let’s stick with 5 years.
The IRS utilizes Accelerated Cost Recovery methods to calculate depreciation which is actually good for us, allowing us to deduct a larger portion in early years. In this case, we are using what they call the Double Declining Balance Method (also known as the 200% Declining Balance Method) which means we divide the asset cost by its useful life, so $1,500 divided by 5 years gives us $300. Then we double the result giving us $600 which is the portion we can deduct in year one. That will leave $900 for us to deduct in future years.
Also, there are other rules which allow you to take a larger portion of the asset in year one that are commonly known as Section 179 deductions but for this example, it is unnecessary. If you want to read more about Section 179, click here.
So, if we do a little more number crunching, we take $103.41 less our $600 in depreciation and suddenly we have a beautiful business tax loss. -$496.59 to be exact.
We have now generated a tax loss that can be used to actually reduce taxable income you might have in another category - from your W-2 or other business income, for example. But we’re not done yet.
Now, think about where you have that rig sitting, clicking and whirring 24 hours a day, performing a valid business function for you but taking up personal space in your beloved resdience. This is my favorite deduction which the IRS refers to as “Business Use of Home.” This can be a tiny number or a relatively decent number depending upon a number of factors. The first thing is to make sure you have a designated space for your mining business. It could be as large as an office completely dedicated to mining or as small as a small desk or stand to hold the PC. The calculation to determine how much of a deduction you can take is based upon the ratio of square footage used for the business to the square footage of the home or apartment. Then take that ratio against the number of hours of use per day. Although 24/7 business use is rarely allowed in a home, this rig is running 24 hours a day so you get 100% of the square footage ratio in my opinion. Next you take that percentage against either the rent paid or the mortgage interest you are paying on the home. You can actually use a portion of your mortgage interest as a business deduction which is better than simply taking it as an itemized deduction if you have gone that route previously. Whatever portion you can’t use for the business deduction can still be taken as an itemized deduction though. This typically isn’t a gigantic amount, but every penny helps.
For simplicity’s sake, let’s say it calculates out to $20. Now you have a business tax loss of -$516.59 which can be used to directly reduce your otherwise taxable income… dollar for dollar.
That scenario is actually a pretty conservative estimate if you are serious about mining and sink some significant money into it. If you are going that route or just tinkering around for fun, I strongly encourage you to seek the advice of a qualified tax professional which, by the way, can also be taken as a tax deduction.
Pitfalls
An important thing to note is that you should actually strive to make a profit within a few years. This is important because if you continue to lose money after three or four years, it is entirely possible that the IRS will deem your little mining project to be a hobby and no longer allow you to use the business loss to offset other taxable income. If you later turn it into a profit-making venture, they will be happy to forcibly reinstate it as a business and collect taxes on your profits. Seriously they will do that.
Don’t worry though, you have done your due diligence and documented thorough research at cryptocomparison.com that you have the equipment to eventually turn a profit, which frees you up to shamelessly take your business loss this year and reduce your tax burden. Good for you.
Now go out there and mine some crypto!
Finally, if you didn’t TL;DR me, I probably saved you honest tax payers a bunch of money. Now send me a Satoshi or two by clicking here and go impress you tax preparer with your newfound knowledge.
Thanks for your sharing this nice read. I especially like your cost estimate including all tax expenses. "Suddenly, that Lambo doesn’t look quite so attainable." - This is not only a true statement that you have made, it is also a message that should be appreciated and fully understood before considering to start mining.
I am looking forward to following you, keep it up!
@wesker
your Cryptocurrency Technical Analyst
do you use some type of accounting/excel spreadsheet to account for all these deductions so that at year end it can easily be allocated? I am curious does a business make the numbers easier because I heard that way one can deduct more.
One more topic of thought. If you held the ether and it does sky rocket let say to $1,000 in the near future and you sold it or exchanged it what happens? Is it a capital gain during that year you sold it or nothing gets documented because you mention you had to document it when you mined it and held onto it.
Thanks.
If you look at my blog and the column I posted about the tax impact of owning cryptocurrencies that will answer a lot of your questions about capital gains. Also the one about the tax fairness act. Thanks for reading
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