Do you spend a good part of your day trading stocks? Normally, net losses incurred by investors have limited tax value at year-end. Plus, you can’t deduct most of your investment-related expenses.
Strategy: Elect stock-trader status. If you qualify, you can deduct 100 percent of your stock losses. In addition, you can write off “ordinary and necessary” business expenses on Schedule C, like other self-employed business people.
To top things off, the IRS entitles day-traders to certain other tax advantages that fall beyond the grasp of regular investors.
Here’s the skinny: After offsetting capital gains and losses for the year, “investors” can use any net capital loss to offset only up to $3,000 of ordinary income. The excess must be carried over to future years. In contrast, traders can deduct all trading losses under the mark-to-market accounting rules. (Of course, they also forfeit the tax benefit of the maximum 15-percent-capital-gains rate on gains from their trader portfolio.)
Also, the IRS exempts traders from the “washsale” rule that prevents loss deductions when reacquiring substantially identical stock within 30 days of the sale. If you’re not a trader, you have to wait at least 31 days to buy back stock you think might rebound or double up on your investment before selling the stock. But the wash-sale rule doesn’t apply to traders.
Other tax benefits: A day-trader can take current deductions for such costs as computer hardware and software, margin interest, investment seminars and investment publications. Traders can use the allowance for qualified property; regular investors cannot.
Finally, traders face fewer technicalities involving constructive-sale rules and straddles.
What are the requirements?
To gain this favorable treatment, you have to plan ahead. For the tax year in question, you must notify the IRS by the prior year’s tax return due date that you intend to use the mark-to-market accounting rules for the following year. So, you can’t size things up late in the year to see if you’ll have an overall loss. Also, once you make the election, you’re stuck with it unless you obtain IRS consent for an accounting change.
You may claim the tax benefits of trader status only if you devote substantial effort to trading securities from your personal account. You must also hold your positions for only a short time.
The IRS has not issued any definitive guidelines for the requirements to achieve trader status.
Tip: Make at least a handful of trades each day to qualify.
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