Stocks & Bonds:

Save Taxes While Trading

Being classified as a trader by the IRS's definition as opposed to an investor can save you a lot of money come tax time. This is because as a trader, you are allowed to deduct all of your investing expenses, including publication subscriptions, your computer equipment and your home office.

First things first. What exactly distinguishes a trader from an investor? Most of the time the answer to that question is not so clear. The part of the tax code that deals with this area is very fuzzy. The best way to determine if you are considered a trader or investor by IRS standards is to follow examples set by previous court decisions on the matter.

The courts consider you a trader if you meet the following criteria:

  • You spend a large quantity of time trading. This means that preferably you do not have a regular full-time job, although you can be considered a part-time trader as long as you are selling and/or buying a couple of stocks almost every day
  • You have established a regular and continuous pattern of trading often (several a day and spend at least about 16 hours a week trading)
  • Your goal is to profit financially from short-term market swings rather than from long-term gains

If you've passed the above test on all accounts, congratulations!! The IRS will probably agree with your assessment that you are a day trader. This title therefore allots you the opportunity to deduct all your investing expenses on Schedule C, like other sole proprietors. This is because you are considered by the IRS to be self-employed and are entitled to the same tax benefits as other self-employed persons. Investors are forced to deduct these expenses on Schedule A where expenses can only be written off if they are in excess of 2% of their adjusted gross income.

Margin account interest can also be deducted on Schedule C as well as, in most cases, an immediate write-off of up to $20,000 in equipment and supplies used in your trading activities more than 50% of the time. You may also take a home office deduction as long as you use the space exclusively for trading purposes and the deduction does not throw you into a net loss position. Another great advantage of being a trader is you do not have to pay self-employment taxes on your net profit. This is because capital gains are exempted.

Gains and losses are still reported on Schedule D and you can still only deduct $3,000 in net capital losses each year. In short, Schedule C will contain no other information (such as income) except for expenses, and Schedule D will contain your trading points.