Do I qualify as a trader or an investor?
There are different tax implications for traders and investors, so it's important to know which you are.
Do I qualify as an investor?
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
Can't use mark-to-market (MTM) accounting, also known as Section 475(f) election
Commissions and costs of acquiring/disposing securities can be considered in gain/loss calculations, but other expenses related to investing are usually not deductible for investors.
Do I qualify as a trader?
For you to be considered a trader, the nature of your trading activities must qualify as a business and 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.
You must carry on the activity with continuity and regularity.
What's a trader of securities and how do I qualify for it?
The IRS considers the following in determining whether your activity is considered 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.
The amount of time you devote to the activity.
A trader must also keep detailed records to distinguish the securities held for investment from the securities in the trading business. The securities held for investment must be identified as such in the trader's records on the day they acquire them (for example, by holding them in a separate brokerage account).
Traders report their business expenses on Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship). Commissions and other costs of acquiring or disposing of securities aren't deductible, but must be used to figure gain or loss upon disposition of the securities. Gains and losses from selling securities from being a trader aren't subject to self-employment tax.
Investors may use the commissions and costs of acquiring and disposing of securities in the gain/loss calculation, too. But, other expenses (except for interest expense in certain cases) related to investing are not deductible.
Investors use Schedule D and Form 8979 to report the sales of securities. Traders can also use Schedule D and Form 8949 to report the sales of securities. If doing so, they’re subject to the same limitations for claiming capital losses and the wash sales rules that are imposed on investors.
However, traders have another alternative. If they have made the proper Mark-to-Market or Section 475(f) election with the IRS, then they may use Form 4797 to report the sales of their securities without the loss limitations and wash sale rules.
How do I make the MTM or Section 475(f) election?
You can make the MTM election by attaching a statement to your income tax return (if filed without an extension) or your tax return extension request. The election can't be e-filed.
The statement should include the following:
A statement that you're making an election under section 475(f)(1) or (f)(2) of the Internal Revenue Code
The first tax year for which the election is effective (that is, the tax year for which a timely election is being made)
The trade or business for which you're making the election
After making the election, it's in effect for the year you select and all later tax years unless you're granted permission from the IRS to revoke it.
You must also change your method of accounting for securities under Revenue Procedure 2019-43 PDF, Section 24.01. You're also required to file a Form 3115, Application for Change in Accounting Method. See Publication 550 for more info.
