How Cryptocurrency Mining Through a Self-Directed IRA are Taxed

The appeal of investing retirement funds outside of the typical investments has driven a surge in the use of self-directed Individual Retirement Account (“IRA”) investment structures. Investments within self-directed IRAs frequently include real estate, closely held business entities, private loans, and can include any other investment that is not specifically prohibited by federal law. This article discusses the tax consequences of cryptocurrency mining through a self-directed IRA and why this area of taxation is not “cut and dried.”

Most individuals who fund self-directed IRAs do not realize that funding such a structure may trigger tax obligations and filing requirements. Anyone considering funding a self-directed IRA must understand the term unrelated business taxable income (“UBTI”). If the self-directed IRA earns UBTI, the IRA may need to file a Form 990-T and pay annual taxes. To calculate UBTI, the income from the business activity that is not passive in nature must be identified. Next, any business expenses must be identified. In addition, if the self-directed IRA utilizes non-recourse debt to acquire property, the self-directed IRA may be subject to Unrelated Debt Financing Tax (“UBFI”) tax. Below, please find two illustrations which demonstrate how the aforementioned taxes and filing requirements apply to self-directed IRAs.

The Taxation of UBTI

An IRA is considered a tax-exempt entity, meaning that it generally does not pay taxes on interest, dividends, or capital gains within the account. As a tax-exempt organization, an IRA is subject to the tax-exempt rules stated in the Internal Revenue Code. Since 1950, exempt organizations have been taxed on unrelated business taxable income, which is defined as gross income (less directly connected expenses) derived from an unrelated trade or business. See IRC Section 512(a). If the property producing such income is acquired with borrowed funds, however, the debt-financed property rules of Internal Revenue Code Section 514 treat all or part of the income as unrelated business taxable income with the result that it is subject to tax.

An exempt organization is taxed on unrelated business taxable income which is defined as gross income (less directly connected expenses) derived from an unrelated trade or business. An unrelated trade or business is defined as: (a) any trade or business; (b) that is regularly carried on; and (c) is not substantially related, aside from the need of the organization for funds, to the organization’s exempt purpose.

In most instances, investment activities of exempt organizations would be regularly carried on and not substantially related to the organization’s exempt purpose, thus meeting the second and third prongs of the definition of an unrelated trade or business. It is less clear whether the conduct of investment activities constitutes a trade or business. The regulations of the Internal Revenue Code provide that, in general, the term “trade or business” has the same meaning it has in Section 162 of the Internal Revenue Code and generally includes any activity carried on for the production of income from the sale of goods or the performance of services. The Supreme Court held in Higgins v. Commissioner, 312, 217 (1941) that an individual’s management of his own investments was not a trade or business even though the individual’s activities were extensive enough to require an office and a staff. Congress ultimately overruled Higgins and enacted Section 121 of the Internal Revenue Code. Section 212 of the Internal Revenue Code allows individuals to deduct “ordinary and necessary” expenses for producing income, managing income-producing property, or handling tax-related matters.

Certain types of income, commonly referred to as “passive income,” are excluded from UBTI. See IRC Section 512(b). These include dividends, interest, payments with respect to securities loans, amounts received or accrued as consideration for entering into agreements to make loans, annuities, royalties, rents from real property and personal property leased with the real property if the rent attributable to the personal property is 50 percent or less of the total and the rent does not depend on income or profits derived from the leased property, and capital gains and losses. See IRC Section 512(b)(5). In addition to passive income, royalties are excluded in computing the unrelated business taxable of a tax-exempt entity. A “royalty” has been defined as any payment received in consideration for the use of a valuable intangible property right, whether or not payment is based on the use made of the intangible property. However, payments for services provided in connection with the granting of this type of rights are not royalties and are generally taxable as unrelated business income.

The UBTI for self-directed IRAs are taxed at progressive trust tax rates, which can reach up to 37% for income over $16,000 (as of 2026). If an IRA generates over $1,000 in annual gross income from unrelated business income. As discussed above, deductions are permitted for expenses that are “directly connected” with the carrying on of the unrelated trade or business, and net operating losses are allowed to be carried forward and backward (with certain limitations). Losses from one unrelated business activity are not able to offset gains in another; profit and losses are determined per activity.

Below, please see Illustration 1 which provides an example as to how UBTI can be assessed against a self-directed IRA holder.

Illustration 1.

Jill invested $500,000 from her IRA into an LLC custom jewelry company. The investment gave Jill a 25 percent interest in an LLC. The LLC had three other owners, not related to Jill, and none of the other investors were co-owners with her in any other business entities. Jill was not involved in the LLC’s day-to-day operations and did not otherwise personally benefit from the investment.  The LLC recorded a significant profit on its annual Form 1065, U.S. Partnership Income Tax Return. In turn, each investor, including Jill’s self-directed IRA was issued yearly Schedules K-1, Partner’s Share of Income, Deductions, Credits, etc., which showed ordinary income. The Internal Revenue Code imposes a tax on income earned by a tax-exempt organization in a trade or business that is unrelated to the organization’s exempt purpose. This type of tax liability is known as UBTI and it became a large tax liability for Jill.

It should be understood that must IRA investments do not trigger current tax consequences, not because all income an IRA earns grows tax free, but because the types of income that an IRA typically earns are exempt from UBTI tax rules. For example, IRAs that invest in publicly traded securities (e.g., stocks, bonds, and mutual funds) do not owe current tax because gains from the sale of C corporation stock dividends, and interest income are exempt from UBTI. For this reason, most IRA investors are unaware that an IRA can require a tax return (Form 990-T Exempt Organization Business Income Tax Return) and pay taxes. Income from a business that is regularly carried on (whether directly or indirectly) can result in UBTI and filing requirements.

In this case, since the LLC Jill invested into conducted a regularly conducted business, the self-directed IRA had a tax consequence. To make matters worse, in Jill’s case, the self-directed IRA was taxed at trust rates. This resulted in Jill’s self-directed IRA realizing a far greater tax liability compared to an individual who is taxed at ordinary marginal tax rates. Jill may be shocked to discover that her self-directed IRA is subject to taxes on the LLC’s yearly profits, but also that the tax rate on income over $16,000 is a whopping 37 percent. To add insult to injury, there was an additional net investment income tax of 3.8 percent assessed on the trust income over $16,000.

The Taxation of UDFI

The exclusion for passive income is not available for income derived from debt-financed property. Section 514(a)(1) of the Internal Revenue Code requires an exempt organization to include UBTI a percentage of income derived from “debt-financed property” equal to the “average acquisition indebtedness” for the taxable year over the average amount of the adjusted basis for the taxable year. A like percentage of deduction is allowed in computing UBTI. See IRC Section 514(a)(2). The straight-line method of depreciation must be used. See IRC Section 514(c)(3). Debt-financed property is defined in Section 514(b)(1) as any property held to produce income with respect to which there is an acquisition indebtedness at any time during the taxable year or, if the property is disposed of during the taxable year, at any time during the 12-month period ending on the disposition. The statute contains several exceptions to the definition of debt-financed property, which have the collective effect of limiting its application to investment income. Specifically, the following are excepted from the definition of debt-financed property: (a) any property substantially all of the use of which is substantially related to the organization’s exempt purpose; (b) any property the income from which is included in UBTI without regard to the debt-financed property rules, except that gain from the sale or disposition of such property is not excluded under Section 512(b)(5); (c) any property to the extent income is excluded under Section 512(b)(7) relating to government research, Section 512(h)(9) relating to college, university, and hospital research, and Section 512(b)(9) relating to fundamental research the results of which are made freely available to the public; (d) any property used in any trade or business described in Section 513(a)(1) relating to work performed by volunteers, Section 513(a)(2) relating to convenience of members, etc., and Section 513(a)(3) relating to selling of merchandise received as gifts; and (e) neighborhood land acquired with the intent of using it for exempt purposes within 10 years.

Acquisition indebtedness is defined as the unpaid amount of (a) indebtedness incurred by the organization in acquiring or improving debt-financed property; (b) indebtedness incurred before the acquisition or improvement of the debt-financed property if such indebtedness would not have been incurred but for such acquisition or improvement; and (c) indebtedness incurred after the acquisition or improvement of the debt-financed property if such indebtedness incurred after the acquisition or improvement of the debt-financed property if such indebtedness would not have been incurred but for such acquisition or improvement and, the incurrence of such indebtedness was reasonably foreseeable at the time of such acquisition or improvement. See IRC Section 514(c).

The statute excludes from the definition of acquisition indebtedness a number of transactions that relate to non-investment transactions common to exempt organizations. These include: (a) a 10-year exception if mortgaged property is acquired by bequest or devise and certain conditions are met; (b) liens for taxes and assessments that attach before the payment date; (c) extension, renewal, or refinancing of an obligation evidencing a pre-existing indebtedness; (d) indebtedness inherent in performing an organization’s exempt purpose such as indebtedness incurred by a credit union accepting deposits from its members; (e) charitable gift annuities; and (f) certain federal financing for low-and-moderate-income persons. The statute also excludes from the definition of acquisition indebtedness securities loans and real property acquired by pensions trusts and schools, colleges, and universities.

If none of the statutory exceptions is applicable, then, to determine whether there is acquisition indebtedness, one must first determine whether there is indebtedness and then determine the indebtedness is traceable to the acquisition or improvement of income-producing property.

Below, please see Illustration 2 which provides an example as to how UDFI can be assessed against a self-directed IRA plan holder.

Illustration 2.

Mark had $1.5 million in his 401(k). Mark decided to invest the $1.5 million in a self-directed IRA. Mark’s goal for his self-directed IRA was to invest in residential real estate through an LLC. Mark found a real estate investment group that frequently organized partnerships and promised “passive” investment (no direct involvement by Mark). The real estate partnership collected capital contributions from 20 investors and used the cash plus debt to purchase an apartment building. The apartment building was held as a rental property, with net income distributed to the investors, including Mark’s self-directed IRA LLC.

As stated above, it is possible for a self-directed IRA to invest in a broad range of investments. Thus, real estate partnerships are acceptable self-directed IRA investments is technically correct. However, this does not answer the question of whether there are more difficult legal or tax issues. For example, “rent from real property” is normally exempt from UBTI, and thus currently not taxable when earned by a self-directed IRA or self-directed IRA LLC. However, income from debt-financed property (whether held directly or indirectly by the self-directed IRA or self-directed IRA LLC) is partially taxable under the  rules because the income generated from the investment is not earned by investment of the self-directed IRA capital, but rather by financing.

In this case, the yearly income that is allocated to Mark’s self-directed LLC is partially subject to tax under the UBFI rules. Income received from debt-financed property may be subject to the  UBFI rules. Because the property placed in the self-directed IRA was financed and subject to the UBTI rules, the self-directed IRA was required to file Form 990-T, annually. This was the case whether or not UBFI taxes were required to be paid. Failure to pay the UBFI taxes and file Form 990-T could subject Mark’s self-directed IRA to significant penalties and interest.

Cryptocurrency Mining in a Self-Directed IRA and UBTI

Cryptocurrency mining involves using computing power to validate blockchains and earn cryptocurrency. Cryptocurrency mining through a self-directed IRA is typically viewed by the IRS as a taxable activity subject to UBTI. The IRS considers cryptocurrency mining a “trade or business” rather than passive activity. This should come as no surprise because cryptocurrency mining operations typically require significant involvement of the investor. The individual or entity involved in cryptocurrency mining must make significant investments in hardware and monitor electricity usage and costs, which are critical to profitability. Individuals and entities involved in cryptocurrency mining operations are often actively involved in the day-to-day operations of the mining activity. By being a material participant in the day-to-day operations of cryptomining, the individual or entity involved in the mining is considered to be in an active trade or business. It is easy to understand as to why the IRS treats cryptocurrency mining activity done through a self-directed IRA as being subject to UBTI. But what about situations where cryptocurrency mining is done on a very small scale through a self-directed IRA, is it possible to treat the cryptocurrency mining as passive rather than as a trade or business and not be subject to UBTI?

This subsection of this article will discuss if it is possible to treat cryptocurrency mining as passive and not subject to UBTI.

Before making a determination if cryptocurrency mining activities could subject a self-directed IRA to UBTI, it is important to consider if a self-directed IRA could be subject to UDFI. If an individual or entity acquired mining cryptocurrency through a self-directed IRA acquired specialized hardware to mine cryptocurrency through debt-financing, the self-directed IRA could be subject to UDFI under Section 514 of the Internal Revenue Code.

Whether or not cryptocurrency mining can be treated as a passive activity that is not subject to UBTI will likely depend on the blockchain network in which the mining activity takes place. Two of the most prevalent decentralized networks are Bitcoin and Ethereum. Bitcoin mining secures the network and verifies transactions by having computers (“miners”) solve complex cryptographic puzzles using high-powered hardware or (“ASICs”). Miners compete to find a specific 64-digit hexadecimal number (hash). The winner adds a new block to the blockchain and receives newly created bitcoin. Bitcoin mining is highly competitive in that participants compete aggressively to find the cheapest sources of power to run their machines, use highly optimized hardware to gain an advantage, and make dynamic decisions about power, timing, and contracts to stay ahead.

Ethereum cannot be mined without a Proof-of-Work form due to its shift to Proof-of-Stake. To generate Ethereum, the person or organization must stake, not mine. However, an individual or organization can still mine other GPU-mintable coins (e.g., Ethereum Classic) using GPUs (Nvidia/AMD) or ASICs (e.g, Bitmain Antminer E9). Ethereum is a permissionless system. Any person or organization willing to stake (lock up) 32 Ethereum can participate in the network. Ethereum operates a marketplace where validators bid to execute transactions and receive “gas” from bidders for executing their workloads on the network. Ethereum validators compete aggressively with one another and use highly optimized hardware and strategies to reduce costs and earn the right to compute workloads.

It is easy to understand how Bitcoin and Ethereum mining can be treated as a trade or business rather than as a passive activity. Other blockchain networks operate under a model completely different from that of the two most prevalent decentralized networks of Bitcoin and Ethereum. Some blockchain networks grant a license and the intangible right to register on their network and receive reward compensation based on a return on risk capital and money payments to offset fixed charges. Payments on these blockchain networks may use an algorithm that emits tokens to a wallet based on time on the network. Some networks may eliminate the “commercial business” from cryptocurrency mining such as selecting hardware, negotiating equipment purchases, and selecting partners. Consequently, mining in certain decentralized networks could potentially be classified as a passive activity or revenue received from royalties. In order to determine if a position can be taken that cryptocurrency mining through a self-directed IRA is passive and not subject to UBTI, a careful examination should be made of the IRAs mining activities by a qualified tax attorney well versed in cryptocurrency and the laws governing self-directed IRAs.

Conclusion

The foregoing discussion is intended to provide the reader with a basic understanding regarding the taxation of cryptocurrency mining through a self-directed IRA. It should be evident from this article that not all cryptocurrency mining done through a self-directed IRA should automatically be classified as a trade or business and subject to UBTI. However, it is important to note that as of this date, the IRS has not issued any regulations, rulings, announcements and the courts have yet to issue any opinions regarding the taxation of cryptocurrency mining through a self-directed IRA. As a result, it is crucial for self-directed IRAs that are investing in cryptocurrency to review its particular circumstances with a qualified tax attorney when planning a proposed cryptocurrency investment.

Anthony Diosdi is a tax attorney at Diosdi & Liu, LLP. He has significant experience defending private clients before the IRS in difficult and complex tax disputes. Anthony counsels clients through examinations and liability disputes and, when necessary, takes disputed issues to court. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or adiosdi@sftaxcounsel.com.

This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.