They have become day traders.
While it looks easy on television, it isn't, and big capital losses often ensue. That's a bad thing when you do your tax returns, because you can only deduct capital losses to the extent of capital gains, plus $3,000. There are day traders out there with loss carry-forwards that they will be still using at that rate when their grandchildren move into assisted living.
There is another way, if you are a truly serious trader: the "Section 475(f) election." If you make this election, you can deduct unlimited capital losses, at least until you run out of money. But it's not for sissies, and it's easy to miss.
If you make the Section 475(f) election:
- You have to mark all of your positions to market - gains and losses - at year end. That means you have to compute your taxes on any open positions at year end as if you had sold them at the year-en closing price.
- Your gains don't qualify for the reduced rate on capital gains.
- You have to be able to demonstrate to the IRS that your trading activity rises to the level of a "trade or business." Unless you have trading on a daily or almost daily basis and look to it for your livelihood, you probably don't make the cut.
Most importantly, you have to make a Section 475(f) election by April 15 of the year for which you want it to be effective. That means if you have big 2011 daytrading losses, it's too late.
To make the election for 2012, you need to follow the steps set out in Revenue Procedure 99-17. That procedure requires you to attach a statement making the election either to a timely-filed 2011 tax return by April 17, 2012 or to a timely-filed extension.
The Section 475(f) election is a serious step, which you should only take in consultation with your tax adviser. But if you a very serious trader, it might pay off big at tax time.
- Joe Kristan