This topic explains if an individual who buys and sells securities qualifies as a trader in securities for tax purposes and how traders must report the income and expenses resulting from the trading business. This topic also discusses the mark-to-market election under Internal Revenue Code section 475(f) for a trader in securities. In general, under section 475(c)(2), the term security includes a share of stock, beneficial ownership interests in certain partnerships and trusts, evidence of indebtedness, and certain notional principal contracts, as well as evidence of an interest in, or a derivative financial instrument in, any of these items and certain identified hedges of these items. To better understand the special rules that apply to traders in securities, it's helpful to review the meaning of the terms investor, dealer, and trader, and the different manner in which they report the income and expenses relating to their activities. Investors Investors typically buy and sell securities and expect income from dividends, interest, or capital appreciation. They buy and sell these securities and hold them for personal investment; they're not conducting a trade or business. Most investors are individuals and hold these securities for a substantial period of time. Sales of these securities result in capital gains and losses that must be reported on Schedule D (Form 1040), Capital Gains and Losses and on Form 8949, Sales and Other Dispositions of Capital Assets as appropriate. Investors are subject to the capital loss limitations described in section 1211(b), in addition to the section 1091 wash sales rules. 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. Review Topic no. 703, Basis of assets for additional information. Investment income isn't subject to self-employment tax. For more information on investors, refer to Publication 550, Investment Income and Expenses. Dealers Dealers in securities within the meaning of section 475(c)(1) ("section 475 dealers") may be individuals or business entities. Section 475 dealers regularly purchase or sell securities to their customers in the ordinary course of their trade or business, or regularly offer to enter into, assume, offset, assign or otherwise terminate positions in securities with customers in the ordinary course of the trade or business. Sometimes section 475 dealers maintain an inventory. Section 475 dealers are distinguished from investors and traders because they have customers and derive their income from marketing securities for sale to customers or from being compensated for services provided as an intermediary or market-maker. Section 475 requires dealers to keep and maintain records that clearly identify securities held for personal gain versus those held for use in their business activity. Section 475 dealers must report gains and losses associated with securities by using the mark-to-market rules discussed below. Traders Special rules apply if you're a trader in securities, in the business of buying and selling securities for your own account. The law considers this to be a trade or business, even though a trader doesn't maintain an inventory and doesn't have customers. To be engaged in business as a trader in securities, you must 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; and You must carry on the activity with continuity and regularity. The following facts and circumstances should be considered in determining if your activity is 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; and The amount of time you devote to the activity. If the nature of your trading activities doesn't qualify as a trade or business, you're generally considered an investor and not a trader. It doesn't matter whether you call yourself a trader or a day trader, you're an investor for Federal income tax purposes. A taxpayer may be a trader in some securities and may hold other securities for investment. The special rules for traders don't apply to those securities held for investment. A trader must 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 the trader acquires 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. See Topic no. 703, Basis of assets. Gains and losses from selling securities from being a trader aren't subject to self-employment tax. The mark-to-market election Traders can choose to use the mark-to-market method of accounting, investors can't. If you as a trader don't make a valid mark-to-market election under section 475(f), then you must treat the gains and losses from sales of securities as capital gains and losses and report the sales on Schedule D (Form 1040) and on Form 8949 as appropriate. When reporting on Schedule D, both the limitations on capital losses and the wash sales rules continue to apply. However, if you make a timely and valid mark-to-market election, then the gains and losses from sales of securities are generally treated as ordinary gains and losses (except for securities held for investment - see above) that must be reported on Part II of Form 4797, Sales of Business Property. The limitations on capital losses, the wash sale rules, and certain other rules do not apply to traders using the mark-to-market method of accounting (see section 475(d)(1)). As a trader, you must make the mark-to-market election by the original due date (not including extensions) of the tax return for the year prior to the year for which you intend the election to become effective. You can make the election by attaching a statement either to your income tax return if filed without an extension or to a request for an extension of time to file your return. The statement should include the following information: That you're making an election under section 475(f); The first tax year for which the election is effective (that is, the tax year for which a timely election is being made); and The trade or business for which you're making the election. If you’re a new taxpayer that wasn’t required to file a tax return for the prior year, you may make the election by placing the above statement in your books and records no later than 2 months and 15 days after the first day of the year for which you intend the election to become effective. You must attach a copy of the statement to your tax return for that year. Refer to the Instructions for Schedule D (Form 1040), Capital Gains and Losses PDF and Revenue Procedure 99-17 PDF for more information on how to make the mark-to-market election. It's important to note that in general, late section 475(f) elections aren't allowed. A taxpayer that misses the deadline for a section 475(f) election generally must wait until the following taxable year and make a valid election for that taxable year. After making the election, the mark-to-market method of accounting is the only permissible method for your securities for the tax year for which the election is effective. If your previous method of accounting for securities was anything other than the mark-to-market method, you must change your method under Revenue Procedure 2024-23 PDF, Section 24.01, by filing a Form 3115, Application for Change in Accounting Method. If you've made a valid election under section 475(f), the only way to stop using mark-to-market accounting for securities is to file both a notification statement that revokes the election under Revenue Procedure 2024-23, Section 24.02, and a Form 3115 to change your method of accounting for securities from the mark-to-market method to a realization method. Under Revenue Procedure 2024-23, Section 24.02, the notification statement must be filed by the original due date (not including extensions) of the tax return for the year prior to the year for which you intend the revocation to become effective. This notification statement must be attached to either that return or, if applicable, to a request for extension of time to file that return. Late revocations are generally not allowed. If you revoke a section 475(f) election within five years of making the election, you must file the notification statement as described above, but you must file the Form 3115 under the non-automatic change procedures of Revenue Procedure 2015-13 PDF (user fee required). Similarly, if you make a section 475(f) election within five years of revoking a section 475 election, you must file the election statement as described above, but you must file the Form 3115 under the non-automatic change procedures of Revenue Procedure 2015-13 (user fee required).
