Tax Treatment of Bitcoin Mining
At one time, there was considerable uncertainty surrounding the taxation of bitcoin mining, particularly as to the issue of timing. That is, when should a bitcoin miner realize income from the activity of mining? At the time the bitcoin is mined? Or later, when it is sold?
The IRS settled this matter with Notice 2014-21. In this notice, the IRS concluded that bitcoin miners must recognize income when the bitcoin is mined, regardless of whether it is ever sold. The amount of income is equal to the market value of bitcoin on the day it was mined. The IRS was silent as to a preferred method for determining market value, but it is presumably acceptable to use any exchange price for bitcoin as long the price is reasonable and the miner uses it consistently going forward. This means taxpayers should not try to use exchanges with an artificially low exchange rate (such as MtGox), nor should they cherry pick the exchange with the lowest price on any given day.
The miner will also have income in the form of a capital gain (or loss) when the bitcoin is sold in the future. However, this does not mean that the miner is double taxed. Because the miner already recognized as income an amount equal to the bitcoin’s market price on the day it was mined, the miner will be allowed to offset this amount when calculating the amount of his or her capital gain (or loss). In other words, this amount is the miner’s cost basis in the bitcoin. Thus, when the coin is sold sometime in the future, the miner will subtract this amount from the sales price in order to determine the amount of taxable gain.
Note that under this timing method, the miner is allowed to deduct mining expenses in the same year the coin was mined, such as electricity and depreciation (subject to loss limitations).
