How to treat Bitcoin mining income for tax purposes?

[twobitcoins]

You are right -- these issues are far from clear.

For my personal tax situation I have come to the conclusion that the 50 BTC awards for solo mining are not in fact created by the miner.  (Consider that you may create a perfectly valid block but another miner wins the race and your block becomes orphaned.  You have created the block, but the reward only exists if the network accepts the block.)  Granted it is a counterintuitive and controversial position.

I don't view my business as creating and selling bitcoins, but rather performing computations in exchange for bitcoins.  The bitcoins are taxable as business income and expenses are deductible as business expenses.  Anything I do with the bitcoins after that, say holding them for 20 years and then selling them, is a personal investment activity, not a business activity.  It's one perspective to consider anyway.

[1714789371]

1714789371

[Stephen Gornick]

holding them for 20 years and then selling them, is a personal investment activity, not a business activity.

So you would book as revenue the bitcoins valued at the current exchange rate at the time they were received (earned) but not actually sell them then?

[twobitcoins]

holding them for 20 years and then selling them, is a personal investment activity, not a business activity.

So you would book as revenue the bitcoins valued at the current exchange rate at the time they were received (earned) but not actually sell them then?

Yes.  That value would become the cost basis, and any price change from then until you sell would be a capital gain or loss.  Bitcoins held for over a year would be eligible for the more favorable long term capital gains tax rates (in the US).

It is risky to generate bitcoins and incur a tax liability without selling, because if the price later collapses you may owe more tax than the value of the bitcoins.  You can sell and take a capital loss, but capital losses can only offset $3000 of ordinary income per year (in the US), so a large mining operation may take many years to recover the funds.  It would be safer to sell at least enough to cover expenses and taxes.

[Epoch]

You are right -- these issues are far from clear.

For my personal tax situation I have come to the conclusion that the 50 BTC awards for solo mining are not in fact created by the miner.  (Consider that you may create a perfectly valid block but another miner wins the race and your block becomes orphaned.  You have created the block, but the reward only exists if the network accepts the block.)  Granted it is a counterintuitive and controversial position.

I don't view my business as creating and selling bitcoins, but rather performing computations in exchange for bitcoins.  The bitcoins are taxable as business income and expenses are deductible as business expenses.  Anything I do with the bitcoins after that, say holding them for 20 years and then selling them, is a personal investment activity, not a business activity.  It's one perspective to consider anyway.

You have obviously thought about this and have reached a defendable position. I do not disagree with your decision; in fact, it is refreshing to see people who have put serious thought into the issues and reached their own conclusions, whatever they may be!

If there is one thing this discussion makes clear, is that there are many ways of interpreting the same bitcoin concepts.

[kjj]

I keep waiting for someone to post an actual official decision letter from the IRS.

[lonelyminer (Peter Šurda)]

For my personal tax situation I have come to the conclusion that the 50 BTC awards for solo mining are not in fact created by the miner.  (Consider that you may create a perfectly valid block but another miner wins the race and your block becomes orphaned.  You have created the block, but the reward only exists if the network accepts the block.)  Granted it is a counterintuitive and controversial position.

The block will be created regardless of whether the network accepts it, it is just valued differently. Say you produce a sweater than noone wants, and compare it to producing a sweater that you'd be able to sell. Why should they be taxed differently?

I guess you could argue either way, since Bitcoin is completely virtual and distributed, there's no single point for a decisive argument.

[Epoch]

I keep waiting for someone to post an actual official decision letter from the IRS.

That would certainly be nice; I'm not sure the IRS has published anything specifically on bitcoin yet. Perhaps @lonelyminer can dig up something specific.

I am aware of a few articles published by US lawyers, however. While not law, they can help set precendent. I have read a few over the past year, though only with mild interest. At the moment I can track down one, an article by John Nelson, a lawyer practicing in Georgia, who in June 2011 wrote this:

http://www.lextechnologiae.com/2011/06/26/why-bitcoin-isnt-a-security-under-federal-securities-law/

The article explains why bitcoin cannot be considered a security or currency under Federal (US) law. It is an interesting read, as are the public comments (and Nelson's responses). It stops short of saying what bitcoin actually is; it is a different article I have read (I'll do some more digging for an actual source) that made a clear legal case for bitcoin as a commodity in the US.

[kjj]

I keep waiting for someone to post an actual official decision letter from the IRS.

That would certainly be nice; I'm not sure the IRS has published anything specifically on bitcoin yet. Perhaps @lonelyminer can dig up something specific.

I assume that we'll all know about it when it happens.  I don't expect the IRS to do anything until either they audit someone that happens to be a trader or a miner, or a trader or a miner specifically asks them for a written ruling.  Either way, it will very likely be a member of the community, and they'd let us know.

[matonis]

I keep waiting for someone to post an actual official decision letter from the IRS.

I wouldn't hold my breath too long waiting for this. A specific decision on bitcoin would give greater legitimacy to bitcoin and the US govt does not want to do that. They would prefer to diminish its credibility.

[matonis]

KPMG LLP gave some guidance for virtual currencies generally in this Nov 2011 study;

"Virtual Currency in Virtual Economies: Implications for Income Tax"
http://themonetaryfuture.blogspot.com/2012/01/virtual-currency-in-virtual-economies.html

[kjj]

I keep waiting for someone to post an actual official decision letter from the IRS.

I wouldn't hold my breath too long waiting for this. A specific decision on bitcoin would give greater legitimacy to bitcoin and the US govt does not want to do that. They would prefer to diminish its credibility.

Meh.  I don't think the government really knows about or cares about bitcoin, at least not in any official way.  And the IRS doesn't care if you slice up babies for lunch meat as long as you pay taxes on the income, so quite likely the IRS is actually the part of the government most likely to embrace bitcoins, or at least taxes paid in dollars for bitcoin-based income.

[jjiimm_64]

I keep waiting for someone to post an actual official decision letter from the IRS.

I wouldn't hold my breath too long waiting for this. A specific decision on bitcoin would give greater legitimacy to bitcoin and the US govt does not want to do that. They would prefer to diminish its credibility.

we dont know that for sure. (They would prefer to diminish its credibility)

I plan on filing by april 15th, and I have mined probably a ~1k btc's since June. I will be declaring the selling of the bitcoins as 'something'.I am  not sure how I am going to do it, but I am definetely writing off the hardware and many kilowatts of power, and declaring the income as income.

[Epoch]

I plan on filing by april 15th, and I have mined probably a ~1k btc's since June. I will be declaring the selling of the bitcoins as 'something'.I am  not sure how I am going to do it, but I am definetely writing off the hardware and many kilowatts of power, and declaring the income as income.

@jjiimm_64, are you in the US or Canada?

[jjiimm_64]

I am in the US

[Epoch]

I am in the US

I ask because in Canada you can only write off 55% of the remaining value of computer equipment per year (termed 'depreciation'), not the full amount.

[jjiimm_64]

I am in the US

I ask because in Canada you can only write off 55% of the remaining value of computer equipment per year (termed 'depreciation'), not the full amount.

interesting.  I was undecided whether to do it all at once or over 3 years, us gives you a choice.

btw,  55% of remaining value? for how many years?  asymptotically

[Epoch]

I am in the US

I ask because in Canada you can only write off 55% of the remaining value of computer equipment per year (termed 'depreciation'), not the full amount.

interesting.  I was undecided whether to do it all at once or over 3 years, us gives you a choice.

btw,  55% of remaining value? for how many years?  asymptotically

Yup, Canada has silly rules for that. Deductions in Canada for computer equipment (55%) would look like this (taking an example of 2 5970's, or $800):
2011 -- $800 x 0.55 x 0.50 – the half-year rule
2012 -- $580 x 0.55
2013 -- $261 x 0.55
2014 -- $117 x 0.55
2015 -- $ 53 x 0.55
2016 -- $ 24 x 0.55
2017 -- $ 11 x 0.55
2018 -- $ 5 x 0.55
2019 -- $ 2 x 0.55
2020 -- $ 1 x 0.55

In the year you purchase the equipment (2011 in the above example) there is the so-called 'half-year rule', where you can only deduct half of the normal deduction. The 'reasoning' is that the government doesn't distinguish between items bought at the beginning of the year or the end ... so they average it and say that you've owned it for 1/2 year. Thus you can only deduct half of the 55% deduction.

Eventually (10 years later) you have deducted the full amount ($800). But 10 years is a long time! It is a stupid rule, but that's what Canadians have to deal with.

[the joint]

I went to H&R Block today to start working on my taxes.

My tax agent and I had to sit an discuss Bitcoin for about an hour.

End result:  She can see how Bitcoin mining/trading/selling is a business, how it is an investment, how it is both, and how it is neither.

She said she needs to do additional research, call the IRS, and get back to me in a week.

She did say, though, that she thinks it will likely be categorized as an investment.

[koin]

She did say, though, that she thinks it will likely be categorized as an investment.

and after seeing your gains will probably be talking about it at the next cocktail party?

[the joint]

She did say, though, that she thinks it will likely be categorized as an investment.

and after seeing your gains will probably be talking about it at the next cocktail party?

She actually said it was "fascinating" and asked me how quickly I made my profits.