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Do I qualify as a trader or an investor?

Designating yourself as a "trader" for tax purposes and designating yourself as an "investor" has separate implications when filing your tax return.

The IRS allows  traders who qualify for "trader tax status" (and operate as a trading business) to choose a method of accounting called Mark-To-Market (MTM).  Mark-To-Market is also known as Section 475(f) election.  The MTM election isn't available to investors. 

To qualify as a trader, you must:

  •  Trade substantially, regularly, frequently, and continuously, and 
  •  Seek to profit from short-term security price swings.

When filing for Section 475(f) as a trader, consider the following:

  • Traders have the option to use the Mark-to-Market rules, but it isn't required 
  • If you make an MTM election, then Form 4797 must be used to report gains/losses, and neither the limitations on capital losses nor the wash sale rules will apply 

Note: If you don’t make the MTM election for accounting, then report gains and losses on Form 8949 and Schedule D of Form 1040, subject to the limits on claiming capital losses and wash sale rules.

To qualify as an investor, you: 

  • Are an individual
  • Buy and sell securities 
  • Hold securities for personal investment over a substantial period
  • Demonstrate activity, which is intermittent and infrequent 
  • Report  gains and losses on Form 8949 and Schedule D of Form 1040
  • Are subject to the limits on claiming capital losses and wash sale rules

A trader must make the mark-to-market election by the original due date (not including extensions) of the tax return for the year prior to the year for which the election becomes effective. This means that for the election to be in effect for the 2022 tax year, the election must be made by the original due date of the 2021 tax return. 

You can make the election by attaching a statement either to your income tax return if filed without an extension or to a request for an extension of time to file your return. The election cannot be electronically filed; it must be attached to a mailed tax return or extension.   

The statement should include the following information:

  1. That you're making an election under section 475(f)(1) or (f)(2) of the Internal Revenue Code;
  2. The first tax year for which the election is effective (that is, the tax year for which a timely election is being made); and
  3. The trade or business for which you're making the election.

After making the election to change to the mark-to-market method of accounting, it is in effect for the year you select and all later tax years unless you are granted permission from the IRS to revoke it. 

Additionally, per the IRS (Topic No. 429 – Traders in Securities):

After making the election to change to the mark-to-market method of accounting, you must change your method of accounting for securities under Revenue Procedure 2019-43 PDF, Section 24.01. In addition to making the election, you'll also be required to file a Form 3115, Application for Change in Accounting Method. Publication 550 describes the procedures for making an election under the section called "Special Rules for Traders in Securities." Non-filing of the Form 3115 mentioned above won't invalidate a timely and valid election.

For more information, see Publication 550 under the section called "Special Rules for Traders in Securities."

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