We usually think of April 15 as the deadline for settling up with the IRS for last year. But for the nation’s doughty day traders — especially the unlucky ones — it’s an important deadline for this year.
The tax law normally limits capital losses to capital gains, plus $3,000. That means many busy traders will have to hope for great advances in life extension technology to ever fully deduct their capital loss carryforwards.
There is an escape from the $3,000 treadmill for taxpayers who qualify as “traders.” The IRS explains what it means to be a “trader”:
To be engaged in business as a trader in securities, you must meet all of 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.
The following facts and circumstances should be considered in determining if your activity is a securities trading business:
- 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.
If the nature of your trading activities does not qualify as a business, you are considered an investor, and not a trader.
These are pretty steep tests. You pretty much need to be trying to do it for a living; another day job is a bad fact, as in this case. But if you pass these tests, you can make a “mark-to-market election” under Section 475(f) of the Internal Revenue Code to deduct trading losses as ordinary. If you make this election on time, it applies to 2014 taxes. It’s too late to make the election for 2013.
The Section 475(f) election comes at a price. If you make this election, gains are ordinary, too, and you have to mark your gains and losses on open positions to market at year-end — paying tax as if you had sold the positions on December 31. Yet if you are exclusively trading short-term, where you pay taxes on gains at ordinary rates anyway and have few open positions at any time, this may not be a great sacrifice.
This election cannot be extended, so traders need to make the election by next Monday. You make the election for 2014 by attaching a statement to your 1040 or extension for 2013 with the following information:
1. That you are making an election under section 475(f) of the Internal Revenue Code;
2. The first tax year for which the election is effective; and
3. The trade or business for which you are making the election.