Tax Planning: Investors vs. Traders
Investment and Asset Management
If you buy and sell securities for your own account, classifying yourself as a trader rather than as an investor may offer significant tax advantages. However, it’s difficult to qualify as a trader — simply calling yourself a “trader” or “day trader” isn’t enough. Here’s what you need to know to help prevent IRS scrutiny and adverse court decisions.
Potentially Favorable Rules
Traders enjoy more favorable tax rules when it comes to deducting investment expenses and the treatment of gains and losses. The Tax Cuts and Jobs Act eliminated most investment expense deductions for investors from 2018 through 2025. Traders, on the other hand, can fully deduct their expenses as ordinary business expenses.
Investors can deduct only up to $3,000 in net capital losses from their ordinary income, such as wages and interest (with any excess carried forward to future tax years). But again, traders have more latitude. A valid mark-to-market election (available only to traders) isn’t subject to the $3,000 limit. Note that in exchange for these benefits, all of a trader’s securities gains and losses — including unrealized gains and
losses as of the last day of the tax year — are treated as ordinary income or loss.
Trading as a Business
Generally speaking, investors buy and sell securities and hold them for a longer term with the expectation that they’ll earn income from dividends, interest or capital appreciation. In contrast, traders typically seek to earn quick profits based on short-term market fluctuations. To show that
they’re conducting a trade or business, traders must participate in sufficiently substantial, continuous and regular trading activities.
Unfortunately, there’s no bright line test for distinguishing between traders and investors, such as a minimum number of hours, days or
trades per year. The IRS and the courts look at factors such as:
- The amount of time you devote to buying and selling securities
- Typical holding periods
- The frequency and dollar amount of trades, and
- The extent to which you rely on these activities for a livelihood.
By default, the IRS considers individuals who buy and sell securities investors.
Weigh Tax Benefits
If you devote a substantial amount of your time to buying and selling securities, talk to your advisors about whether you qualify as a trader. If you think you do, weigh the tax benefits of filing as a trader against the risk that the IRS will challenge your trader status.