Holding
periods and gain/loss characterizations
Long-term
gains are defined as securities held for more than a year.
Short-term gains are defined as securities held a year or less. Since
short-term gains are taxed at your income rate (possibly as high as 35%) and
long-term gains are taxed at a fixed 15%, it is tax efficient to sell for
a gain after you have held a stock for more than a year (long-term) and
sell for a loss when you have held a stock for a year or less
(short-term). Smart investors will try to offset all short-term gains with
short-term losses before year's end. In addition, after you offset all
your capital gains, you can use any remaining losses to offset as much as
$3,000 in ordinary income.
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Annual $3,000 capital loss limit
If
you have a net loss position, the IRS allows you to write off $3,000 per tax
year. If you have net losses greater than $3,000 you can carry those additional
losses forward to subsequent tax years.
Complete the Capital Loss Carryover Worksheet in the Schedule D to determine what
portion you are carrying forward. Utilizing the $3,000 capital loss write
off can result in substantial savings for taxpayers.
Married
couples are only allowed to write off a total of $3,000. The annual limit
for married couples filing separately is $1,500 each. This is a true
marriage penalty.
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Wash Sales
The IRS created the Wash Sales rule to prevent tax-payers from realizing losses for tax purposes and then buying back
into the same security.
You cannot deduct losses from securities if you re-purchase that security either 30 days
before or after you sell it for a loss. If you do re-purchase the
security within the 61-day window, the loss is deferred. The
loss is added to the cost basis of the replacement shares purchased, and the
holding period of the replacement shares includes the holding period of
the original shares sold.
Confused yet? Let’s say you sold 100 shares of Amazon for a $3,000 loss and
then re-purchased 100 shares, within 30 days, for $5,000. Because of the
wash sale, you are not allowed to report the $3,000 loss on your Schedule
D and the cost basis of the new lot becomes $8,000.
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Are you an Investor or a Trader?
If you
meet the IRS's definition of a "Trader", you can save big
bucks come tax time. According to the tax law, "Traders"
are in the business of buying and selling
securities. ----- Not so fast! I know what you are
thinking. "I'm a trader". Shoot, you probably flipped
three stocks last week for over a $6,000 gain. Unfortunately,
even if you have two online accounts and you place a few
trades a week, the IRS still considers you
an "Investor."
How to Qualify as a "Trader"
To determine if you qualify as a "Trader"
versus an "Investor", we can only follow
the guidelines
determined
by several court cases addressing
this issue.
SmartMoney
states, "The court
says you are a trader if:
-
You spend lots of time trading
(more than 20 hours a week). Preferably, you don't have a regular
full-time job.
-
You have established a regular
and continuous pattern of making lots of trades. Probably multiple buys
and sells for every day the market is open. Vacations are understandable,
but lapses of weeks or months without any trading activity
will immediately move you from "Trader" to "Investor" status.
-
Your goal is to profit from
short-term market swings rather than from long-term gains or dividend
income. What is profiting from short-term market swings? Getting in and
out of a position on the same day or within a week. Holding stocks for
a month or two blows any chance of claiming trader status.
-
You don't use the Small Order
Execution System (SOES) for your trades. Only amateur investors are
allowed to use SOES, by using SOES you would be telling the SEC you are an
amateur while trying to tell the IRS you are a pro trader.
-
Satisfy the above requirements
for an unbroken string of at least six months.
Benefits
of "Trader" Status
-
Deduct all your investing
expenses on Schedule C, like any other sole proprietor. This eliminates
the need to claim these expenses on Schedule A and eliminates the
limitation of only writing off the amount that exceeds 2% of your
gross income. Furthermore, Schedule C write-offs reduce your adjusted
gross income, which makes it more likely that you can fully deduct all your
personal exemptions.
-
Deduct your margin account
interest on Schedule C.
-
Write-off up to $25,000 a year
for equipment used in your trading activities (computers, magazines,
Bloomberg, fax machines, office material) under Section 179.
-
Exempt yourself from all
wash-sale rules (See Wash-Sales for more info.)
-
Deduct an unlimited amount of
losses versus the investor's limit of $3,000 in capital losses."
Is
it possible to qualify as both a
"Trader" and an
"Investor?"
Sure is! The trick is to handle your
"Trader" investments differently than your "Investor"
investments. In order to treat investments differently, you
must separate your long-term holdings (Investor Status)
from short-term holdings (Trader Status) by identifying
them as such in your records on the day you buy the holding.
It would help your claim as both Trader and Investor
status if you actually
created a
separate account. That is, a trader
account and an investor account.
Please consult your tax advisor for
details on filing Schedule D and C under
"Trader" status and the
IRS Revenue Procedure 99-17 at the IRS website, or goto Tax
Forms to download the
latest IRS tax forms. The information provided above is
intended as a preliminary
status check, not the bible in Tax
Law.
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Presentation
Matters
One
final note to remember when filing your tax return: be sure to
provide accurate backup documentation of your trading records.
This will appease the IRS and minimize the chances of an audit on your return.
Also, be sure to include backup confirmations from your broker on all specific lot transactions
with your tax return.
Rule of thumb, if you can’t figure out your own report, chances are the IRS won’t either.
The last thing you want is a mandatory appointment with an IRS agent next summer to decipher
your records.
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