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3 Ways to Avoid the Wash Sale Nightmare!

3 Ways To Avoid The Wash Sale Nightmare!

As you approach the end of a tax year paying attention to the Wash Sale Rule is something that will keep you safe; and avoid being a wash sale casualty. The rule was created to prevent “tax loss harvesting”.

A basic wash sale happens when a security is sold at a loss, then repurchased in a short period of time before or after the loss. The IRS has established the wash sale rule in order to prevent anyone from reducing their capital gains by creating wash sales. The most important time of year for day traders to pay attention to is December & January!

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Day Trader Saves $20K In Taxes Using an LLC!

One of the most frequently asked questions I receive is, “Do I need to incorporate my trading within an entity”? Potentially a Partnership, SMLLC, S-Corporation, or C-Corporation?

The quick answer is — IT DEPENDS.

I wish there was a one size fits all solution to this question.

Each traders facts and circumstances is completely different the next.

🧟‍♂️ Connect With Me On Social Media! https://linktr.ee/BrianRivera

Interested in booking a consultation to discuss your situation in detail?

Don’t forget to check out our Day trader Blog Resource Center!

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How To Qualify For Day Trader Status

The IRS buckets everyone by default as an “investor” for tax purposes.

In this video we discuss the criteria that needs to be met in order to qualify as an active day trader in the eyes of the IRS.

This is not an application but a set of facts and circumstances that must be met each year to meet the qualification!

B – Business Expenses

E – Equipment Used in Trading

H – Hours Spent in The Market (4+ per day)

A – Average Holding Period Not To Exceed 31 days

V – Volume of Trades (720+)

E – Extent at which you trade (75% of market days)

If you qualify you get TWO main benefits:

a) Business Expense Treatment and

b) The opportunity not “right” to Section 475 M2M

🧟‍♂️ Connect With Me On Social Media! https://linktr.ee/BrianRivera

Interested in booking a consultation to discuss your situation in detail?

Don’t forget to check out our Day trader Blog Resource Center!

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Trader Status

The term Trader Status is used frequently among the trading community. But what does this exactly mean to the Active Trader? According to IRS Topic 429 in order to qualify for Trader Tax Status you must meet the following conditions:

-You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation;

-Your activity must be substantial; and

– You must carry on the activity with continuity and regularity.

Pretty boiler plate at best right? To take it a step further the IRS has established the following criteria:

– Typical holding periods for securities bought and sold;

– The frequency and dollar amount of your trades during the year;

– The extent to which you pursue the activity to produce income for a livelihood; and

– The amount of time you devote to the activity.

Trader Tax Status drives many key business tax breaks like business expense treatment and ordinary income/loss treatment with a Section 475 (Mark-to-Market)election. If an active trader elects to trade through an S-Corporation Entity they can also unlock employee benefit plan deductions for retirement and health insurance premiums. All deduction items are allowed to be deducted from gross income without limitation.

How to Qualify

The wonderful and complicated issue with Trader Tax Status is that there is no bright-line test. There is no application or endorsement for Trader Tax Status.  The best way to determine qualification is look at past case law studies and the outcomes reached by the courts. Based on our research of past court cases we’ve identified some Active-Trader parameters in the event a trader had to defend him or herself in Tax Court. We like to say that in order to qualify for Trader Status an active trader must B.E.H.A.V.E.

B – Business Expenses customary to a trader (i.e. News Feeds, Data Level 2 Feeds, Chat/Educational Services, and Office Space)
E – Equipment used for trading such as computers and multiple monitor set-ups.
H – Hours 4 or more hours per day including research and administrative tasks.
A – Average holding period not to exceed 31 days
V – Volume of trades at least four or more trades per day with at least 15 or more for the week. Note that a round-trip trade (buy and sell) would be considered two trades.
E – Extent of Activity must be at least 75% of the available trading days.  On average 4 out of 5 days per week must have a trade execution.

In addition to our BEHAVE parameters a trader must possess the motive to run business and make a living. You must trade your own capital (ideally above Pattern Day Trader Requirements of $25,000 but not a deal breaker). It does not have to be your primary means of making a living but the motive for trading is to be successful and make money. If you have additional sources of income the best way to prove your legitimacy is through the establishment of a trading entity (Partnership, LLC, or C-Corp). Note that trading in retirement funds does not qualify for trader tax status and should be shielded separately of a trader’s business activity.

We don’t advise going it alone. If you make one mistake, the IRS can deny your trader tax status or mark to market election, costing you thousands of dollars in lost deductions.  A good way to get started with our firm is to schedule a 30 minute consultation to asses your situation.

We can help you with the following services:

  • Establishing trader tax status
  • Electing mark to market (IRC Section 475) & filing out the appropriate forms
  • Trader entity consultation
  • Trader Entity Formation
  • Trader Tax Preparation
  • Tax Planning to maximize your deductions
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Mark To Market Accounting

Think of this as a Trader Tax Loss Insurance Plan!

You can only claim Mark To Market Accounting IF you qualify for trader status.  Not sure if you qualify for trader status? Refer to this post.

One of the biggest advantages of claiming trader tax status is the ability to elect mark to market accounting (IRC Section 475). The Mark to Market method has the effect of converting capital gains and losses into ordinary gains and losses.  All open positions are priced as if they were sold on the last trading day of the year (marked to market) and then “bought back” at the same price on the 1st trading day in January. Your unrealized gain or loss is then recorded for tax purposes on Form 4797.

Advantages of Mark to Market Accounting

  • No Wash Sales: Traders using mark to market accounting are exempt from the wash sale rule
  • Losses are FULLY deductible: this is the biggest reason to make the mark to market election. Losses are converted into ordinary losses (not capital losses), so you are not restricted by the $3000 capital loss limitation. This allows a trader to deduct all losses in the year that they occur, provided there is other income to off set it. You can even carry back the losses to previous tax years!
  • No change to self-employment tax exemption

Disadvantages of Mark To Market

  • No Capital Loss Carryover: if a trader is carrying capital losses, electing mark to market will change the classification of the trading gains going forward. Gains will be ordinary gains and any capital losses cannot be used to offset those gains (capital losses only offset capital gains).
  • Election is permanent: Once you make the election, you have to continue to use the mark to market method for all future years. You can change the election ONLY with the consent of the IRS (good luck), and they generally won’t grant this consent if your reason for changing is simply that the election didn’t turn out to your advantage.

How to make the Mark to Market Election

In order to make the mark to market election, a trader must enclose a statement of intent with the prior year’s tax return (or extension request) by April 15. For example, if you intend to switch to the mark to market method for 2021, you will enclose an election statement with your 2020 tax return by April 15, 2021.

Then you’ll need to fill out and send in Form 3115 (Change of Accounting Methods) with your tax return for the following year. For instance, if you elect mark to market for the 2021 tax year, you’ll fill out and send in Form 3115 with your 2021 tax return by the April 15, 2022 due date.

If you have any open positions on January 1 of the year you make the election, you’ll also need to calculate and report Section 481(a) adjustments on Form 3115. This “marks to market” any open positions you have at the time you make the switch. Any unrealized gains over $25,000 can be prorated over 4 years and any unrealized losses can be taken in full on the current year’s tax return.

Be careful when making the election to the mark to market method. If you make any mistakes or miss any deadlines on sending in the right forms, you will lose out on the mark to market tax benefits.

Consult Us

Does the Mark To Market election make sense for you?  Have you accumulated capital losses over your trading career and finally reached your “break-through” year to where you have achieved profitability?  Does the mark to market method make sense for you? No two traders are the same and there isn’t a one size fits all approach to making this election.  If you need help schedule a 30 minute consultation to help determine if Mark to Market accounting is right for your trading business.