How to Day Trade and Deal With Tax Preparation
Just because you call yourself a day trader doesn't mean the Internal Revenue Service considers you to have a business as a securities trader. Traders have the advantage of deducting all their expenses as business expenses. Ordinary investors can only deduct investment expenses that exceed 2 percent of adjusted gross income, and they must itemize deductions. A securities trader is also allowed to compute taxable income on gains and losses using securities values at year-end, which is called mark-to-market. This election allows traders to escape rules that limit annual loss deductions. Investors normally are limited to an annual deduction of $3,000 for capital losses.
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Things You'll Need
- IRS Form 3115 (see Resources)
- Ledgers or spreadsheets
- IRS Form 4797 (see Resources)
- IRS Schedule D (see Resources)
Instructions
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Determine if you meet the qualifications for a securities trading business. You must have continuous regular trading activity that is substantial from which you seek to profit from daily market movements in the prices of securities rather than from dividends or capital appreciation. You are unlikely to qualify as a securities trader if you don't trade every day and don't rely upon trading for your livelihood.
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Inform the IRS of your choice to use mark-to-market accounting if you qualify as a trader and wish to make this election, and file Form 3115.
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3
Open a brokerage account for securities held for investment. Even if you qualify as a securities trading business, you need a separate account for securities you identify as held for investment rather than trading.
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Create an accounting system to record purchases and sales of securities in each brokerage account.
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Maintain lists of expenses paid that are related to securities trading and investing activities. Provide these lists to your tax professional at the end of the year.
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Provide records of securities trading purchases and sales to a tax professional. A securities trading business with a mark-to-market election reports gains and losses on Form 4797. Present separate records for purchases and sales of securities held for investment purposes, which are reported on Schedule D.
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