Mining Virtual Currency: What Are the Tax Implications and Consequences?
Dustin Wells, Tax Specialist
In May’s newsletter, we addressed virtual currencies and, more specifically, the tax consequences and recognition required due to the new IRS initiative, IRS: Hidden Treasure. In this article, we will develop and address the tax consequences related to the mining of virtual currencies such as Bitcoin, Ethereum, etc. as well as related tax issues, reporting surrounding charitable donations of your virtual currency.
Recently, a client asked for a meeting to address certain virtual currency activities including (data) mining for virtual currency that they had undertaken vigorously in 2020. This piqued my interest to say the least, especially after writing the article linked above. In summary, this particular client has undertaken (data) mining of the virtual currency, Ethereum, as well as participating in other virtual currency ideas and transactions with tax consequences.
As a reminder, per the IRS, virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency. For more information on the tax treatment of virtual currencies, see Notice 2014-21. On top of that, you must report income, gain, or loss from all taxable transactions involving virtual currency on your Federal income tax return for the taxable year of the transaction, regardless of the amount or whether you receive a payee statement or information return.
Let’s explore simpler transactions and reporting, and then move to more detailed transactions.
First question: What are the tax consequences if I mine virtual currency and/or receive digital compensation for the mining of virtual currency? In all, once you successfully mine in full or in part (a) virtual currency, the IRS has deemed that a taxable transaction for which ordinary income to the “holder”, the owner of the mined virtual currency, should be reported to the IRS by the “holder”. If these virtual “monies” are received in part(s) or in full during the taxable year, it would be best for the “holder”, the owner of the virtual currency, to catalogue and track the exact amount of virtual currency, bitcoin, ethereum, etc. mined as well as the value as of the receipt date of the specific virtual currency so that those amounts can be presented to your CPA or local tax representative who prepares your tax returns. With this information, your CPA and or local tax rep should check the box required for virtual currency activity on Form 1040, pg.1, and then outline the taxable transactions, to what extent is deemed ordinary taxable income via Form 1040, Schedule 1, Other Income, for the amounts of those mining transactions in total.
Second question: What if I sell some or all of the virtual currency I mined and/or purchased previously? As a reminder, per the IRS, when you sell (a) virtual currency, you must recognize any capital gain or loss on the sale, subject to any limitations on the deductibility of the capital loss(es). For more information on capital assets, gains, and losses, see Publication 544, Sales and Other Dispositions of Assets. Additionally, your gross sales price will be what you sold the virtual currency for on the date of sale given the specific virtual currency index and your cost basis will be the previously recognized FMV (fair market value) of said virtual currency on the date of receipt, as previously recognized in ordinary income from mining prior. Therefore, you would have a recognized capital gain or loss from your sale of virtual currency reported on Schedule D, and if capital loss(es) recognized, that capital loss(es) would be further limited to $3,000 given the capital loss limit requirements. These transactions, sales, dispositions, etc. should be reported with Form 1040 via Form 8949 and/or Schedule D to the extent required with an additional classification of short-term, less than a year, and long-term, more than a year.
Third question: What if I received cryptocurrency as a bona fide gift? Do I have taxable income? Generally, no. if you receive cryptocurrency as a bona fide gift – not for performed services, or other income producing activities – then, you will not be required to recognize income until you sell, exchange, or otherwise dispose of the gifted virtual currency. Additionally, your basis in that virtual currency received as a bona fide gift will depend on whether or not you have held said gifted virtual currency for a year or less. If recognizable gain required, your basis is the donor’s basis, plus any gift tax paid; however, if you sell for a loss, then our basis in the virtual currency will be the lesser of the donor’s basis (or) the fair market value of the virtual currency at time you received the gift. Lastly, the IRS states, if you do not have documentation to verify donor’s basis, then your basis will be deemed to be zero. For more information on basis of property received as a gift, see Publication 551, Basis of Assets.
Fourth question: What if I donate some or all of my virtual currency I mined and/or purchased previously? What do I report? Very interesting question for which more details will be needed on an individual basis. For reference, per the IRS, virtual currency is property and treated for capital gain and loss as well as charitable contribution deductions similarly as stock – a noncash contribution. Therefore, what if you were to donate stock and/or virtual currency to your church or another charitable organization? What happens then? In summary, if you donate virtual currency to a charitable organization as described in the Internal Revenue Code Section 170(c), you will not be required to recognize taxable income, or (a) gain or loss from that charitable contribution donation similarly to how no income, gain or loss would be required if you donated stock as a noncash charitable contribution. For more information on charitable contributions, see Publication 526, Charitable Contributions.
Fifth question: What is my charitable contribution deduction if I donate virtual currency to my church or another valid charitable organization? In general, your charitable contribution deduction will be equal to the fair market value of the virtual currency at the specific date and time of the (virtual currency) donation if you have held the virtual currency for more than one year. If you have held the virtual currency for one year or less at the specific date and time of the donation, your deduction is the lesser of your basis in the virtual currency or the virtual currency’s fair market value at the time of the contribution. Presuming the cryptocurrency continues to increase in value, as Bitcoin and Ethereum have, it’s likely best to hold for one year before you donate so you’re able to take advantage of claiming the FMV on the date of the gift. Additionally, if the donated virtual currency is worth more than $250 and under $5,000 at the date and time of gift, you and the charitable organization should execute Form 8283 – Noncash Charitable Contributions, to acknowledge receipt of the charitable donated property. Moreover, if the cryptocurrency donation is worth more than $5,000, along with Form 8283 and both parties signature acknowledgements it would be best to attach the indexed value for the date of the gift.
Additional information can be found here: IRS Virtual Currencies, as well as Notice 2014-21 and Rev. Rul. 2019-24. Moreover, if you have any other virtual currency questions, concerns, etc. you can submit an inquiry on the “Contact Us” page of our website. Our team would be happy to help, wherever we can.