IRS rules grant extra deductions
to those high-rolling day traders
By Cora M. Barnhart • Bankrate.com

With the advent of do-it-yourself Internet brokerages, a new occupation arose that blends Wall Street investor and high-risk gambler -- the day trader.

For tax purposes, however, the Internal Revenue Service draws a distinction between day traders and investors -- and treats them very differently on April 15.

Time, intensity and goals are keys
While more of us use the Internet to track, monitor and trade stocks, most taxpayers aren't true day traders. Most are investors in the eyes of the IRS.

This distinction matters at tax time: Investors' expenses are itemized deductions, day traders have deductible business expenses.

What does it take to be a day trader? According to a Q&A from the IRS, true traders buy and sell securities frequently, but engaging in extensive trading isn't enough. To be a trader, you must profit primarily from swings in daily market movements and personally engage in the purchases or sales.

Time, intensity and profit goals help the IRS draw the line between investors and traders. Taxpayers who spend a lot of time trading, especially those who don't have full-time jobs, are more likely to be considered traders. Basing trades on profits from short-term market changes, as opposed to long-term gains and dividend income, also will increase your chances of being perceived as a trader by the IRS.

Investors and Schedule A
If, like most taxpayers, you're not a trader, the IRS will consider your expenses in this area to be the miscellaneous itemized sort. Account for them on Schedule A.

After combining your investment expenses with other expenses, such as those for tax preparation, you will only be able to write off whatever amount of the total exceeds 2 percent of your adjusted gross income. Use Schedule D to account for your gains and losses.

Investors cannot use their trading activities to claim many of the deduction perks that are available to true day traders. However, they can use any interest paid on a margin account to offset income earned from their investments.

Traders, deductions and Schedule C
If you do meet the IRS tests for traders, you can deduct expenses that arise from your trading activities.

The first piece of good news is that you are considered self-employed. You get to deduct expenses, such as interest on your margin account, on Schedule C. These write-offs have the added benefit of reducing your adjusted gross income. Reducing this could qualify you for a number of other income sensitive deductions.

Day traders also are likely to qualify for two other tax savings for sole proprietors. Any personal equipment used primarily (at least 50 percent of the time) in trading activities qualifies for a Section 179 write-off. This allows a taxpayer to deduct up to $19,000 in expenses this year instead of having to spread them out over time. In addition, if you use a room in your home regularly and exclusively for trading, you can probably take advantage of a home office deduction.

Be careful, though. The tax benefits associated with true day trading aren't enough to offset the financial risks for everyone. Think twice before you quit that day job.

-- Posted Jan. 6, 2000