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Tax Talk with George Saenz

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Day-trading tax rules

Dear Tax Talk:
I am looking at making my money by doing stock trades exclusively. Would I only pay taxes based on capital gains, and as an individual, what can I deduct as expenses?

Dear Dale:
I thought day trading went down the tubes with the tech boom. I have quite a few millionaire clients that have several less million from attempting to outsmart the swings of the market.

If you want to try your hand at day trading to make your money, don't give up your night job and follow my tax advice. First, day trading pretty much means that you'll buy stock one day and sell it the same or the next. This means all your trades are short-term and will be taxed at the same rate as other ordinary income.

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Since short-term gains are taxed at the same rate as other income but losses could be limited, it makes sense to make the mark-to-market election applicable to day traders. By making this election, your trades are reported on Form 4797 instead of Schedule D.

To make the election to be a trader you have to have sufficient trading activity. In making this determination you'd look at:

  • 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.

If your trading activities are not a business, you are considered an investor, not a trader. It does not matter whether you call yourself a trader or a "day trader."

Interest expense and other investment expenses that an investor would deduct on Schedule A, Itemized Deductions, are deducted by a trader on Schedule C, Profit or Loss From Business, if the expenses are from the trading business. Commissions and other costs of acquiring or disposing of securities are not deductible, but must be used to figure gain or loss. The limit on investment interest expense, which applies to investors, does not apply to interest paid or incurred in a trading business.

It is too late to make the mark-to-market election for the 2003 tax year. To make the election for 2004, you must file a statement by April 15, 2004. This statement should be attached to either your 2003 individual income tax return or your request for an extension of time to file that return.

The statement must include the following:

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.
3. The trade or business for which you are making the election.

-- Posted: Sept. 5, 2003

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