IRS Tax Laws for Day Trading

by Karen Rogers
Day traders enjoy some tax breaks that are unavailable to the occasional investor.

In the eyes of the IRS, there's a world of difference between the investor who occasionally trades and a day trader. IRS tax laws exempt day traders from wash sale restrictions and capital loss limits. In return, the IRS expects day traders to keep scrupulous records of their trading activity and file accurate, timely income tax returns. If your goal is to earn small profits from numerous daily trades, you might want to have the IRS designate you as a day trader.

Day Trader Designation Application

You must apply to the IRS to get the day trader designation. When you file your tax return, attach a statement stating why your trading activity meets the IRS day trading definition. The IRS looks at three things to determine if you are a day trader. First, you must look to profit from daily price movements in the security. Second, when the IRS looks at your tax return, all or most of your income must come from day trading to meet the substantial activity rule. Third, you must day trade on a regular and continual basis.

Mark-to-Market Election

You can elect to treat your day trading gains and losses as ordinary business gains or losses by making the mark-to-market election. For tax purposes, the mark-to-market election values your securities as if you had sold them on the last trading day of the year. You must attach a statement with your tax return stating that you are making the election under section 475(f) of the Internal Revenue Code. You must identify the tax year you want the mark-to-market election to apply to and to which of your trade or businesses the election should apply.

Wash Sale Reporting

Under IRS regulations, investors who sell stock or securities at a loss then turn around and buy or reacquire the same security within 30 days are subject to wash sale rules. They cannot deduct the wash sale loss or use it to offset a capital gain. As a designated day trader, however, you are exempt from the wash sale regulations. Since day traders can buy and sell the same security repeatedly each day, the loss is considered a business loss and is fully deductible. You must make the mark-to-market election to deduct your wash sale losses.

Reporting Gains and Losses

Day traders who make the mark-to-market election report their trading gains and losses on Form 4797, Sale of Business Property, in Part II, Ordinary Gains and Losses. You do not complete Schedule D. With the mark-to-market election, the $3,000 capital loss limit does not apply to day traders. You can deduct the total amount of your losses. After completing Form 4797, you transfer the gain or loss directly to your 1040 income tax return.

About the Author

Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.

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