Looking at ways to reduce your realized capital gains on the year? A strategy investors can use is called tax loss harvesting also known as tax loss selling!
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!
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:
Once a trader has experienced success and the wonderful opportunity of paying taxes they quickly realize the importance of trader tax status — it unlocks a wealth of benefits.
One of the most frequent questions I receive from traders is, “What is the difference between filing a return as a trader vs. investor”? If I could sum it up in one word it would be DEDUCTIONS!
If you qualify for trader tax status, you get to file a business tax return and claim business expenses. This allows you to take many more deductions than you’d be able to take if you filed as an investor. Investors are severely limited under the tax code from deducting trading expenses.
Let’s look at a comparison side by side:
| Type | Investor | Trader |
| Capital Loss and Wash Sale Rules | Yes | Yes |
| Investment Interest Expense | Limited | Unlimited |
| Investment Expenses | Limited | Unlimited |
| Form Expenses Recorded on? | Schedule A | Schedule C or Business Return |
| Mark to Market Accounting? | Not Allowed | Yes |
| Home Office Expenses | Not Allowed | Yes |
| Education Expenses | Not Allowed | Yes |
| Depreciation of Computers & Equipment | Limited: Subject to 2% Floor | Yes |
| Net Operating Loss Carryback | Not Allowed | Yes |
**Based on IRS Tax Topic 429**
EXPENSE LIMITATION
Looking at the above list you can see that filing your tax return as an investor limits the amount of expense deducations you are able to take. Since all expenses for an investor are filed on a Schedule A, they are classified as miscellaneous itemized deductions. This means that they must be greater than 2% of your adjusted gross income. It also means you can deduct only the amount that exceeds the 2% limit!
2018 UPDATE: The Tax Cuts and Jobs Act eliminated all miscellaneous itemized deductions for investors; giving you more reason to qualify for trader tax status.
For example, if your AGI is $100,000, your expenses must be greater than $2,000 in order for you to deduct them. If your expenses are $3000, you can deduct only $1000 (the amount over the 2% limit) from your taxes.
Traders are not subject to this limitation since they will claim all of their business expenses. This enables them to deduct ALL expenses associated with their trading business.
INVESTMENT INTEREST EXPENSE LIMITATION
Investors can deduct margin interest as an itemized deduction on their Schedule A but only to the extent of their net investment income. Any excess investment interest expenses are carried over to the following tax year to be deducted in the same way.
Traders are not subject to this limitation. They deduct margin interest in full on Schedule C as a business expense instead of an itemized deduction. Since margin interest for most traders can run many thousands of dollars, this is a HUGE tax advantage.