Day Traders and Capital Gains
Discover if day traders are required to adhere to any special IRS rules in regard to capital gains and capital losses in this guide.
Very active traders generally are in the same boat as regular investors when it comes to gains and losses. Regardless of how frequently they trade, their sales generate long- or short-term capital gain or loss reported on Schedule D.
Whether a taxpayer's investment activities are sufficient to constitute carrying on a trade or business requires an examination of the facts in each case.
Caution
The vast majority of taxpayers who manage their own investments are investors rather than traders. Proving that one's investment activities rise to the level of carrying on a trade or business is a difficult hill to climb.
In determining whether a taxpayer who manages his own investments is a trader who is engaged in a trade or business, or an investor who isn't, courts consider the:
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Taxpayer's investment intent;,
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Nature of the income to be derived from the activity; and,
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Frequency, extent, and regularity of the taxpayer's securities transactions.
According to the Tax Court (and this issue has frequently been there), the distinction between a trader and an investor is that a trader buys and sells securities with reasonable frequency in an effort to catch the swings in the daily market movements and thus profit on a short-term basis. On the other hand, an investor purchases securities to be held for capital appreciation and income, usually without regard to short-term developments that would influence the price of the securities on the daily market.
Written Election Required
To be a day trader a taxpayer must make the mark-to-market (MTM) rules election. To make that election, the taxpayer generally must file a required statement no later than the due date (without regard to extensions) of the original federal income tax return for the tax year immediately preceding the “election year.” The statement must be attached to that return or, if applicable, to a request for an extension of time to file that return. (Rev Proc 99-17, 1999-7 IRB 52, 5.03(1))
It May Be Too Late - Example
For the election to apply to the 2024 year, it must have been made by April 15, 2024
Tax Treatment
Day traders who have elected to follow the mark-to-market (MTM) rules apply the following tax treatment to their transactions:
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Gain or loss is recognized on any security (or commodity) held in connection with his trade or business at the close of any tax year as if the security (or commodity) were sold for its fair market value on the last business day of the tax year, and,
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Gain or loss is taken into account for the tax year as ordinary income or loss.,
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Wash sale rules do not apply.,
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Form 4797 and not Schedule D/Form 8949 is used to report the gains and losses.
In other words, a stock trader who closes out the year with a net loss can use it to offset ordinary income without any limitations and may wind up with a net operating loss that, starting in 2021, can be carried forward indefinitely. NOLs occurring in 2018, 2019 or 2020 can be carried back 5 years and then forward.
Day traders are not subject to SE tax even though considered in a trade or business.