trader vs. investor question

[ksda]

I've been reading about what it takes to qualify as a trader for tax purposes so that you can avoid the wash rule, but a lot of the details seem a bit vague. I was hoping someone could clear some things up for me. According to this website http://www.forbes.com/sites/anthony...sales-of-stock-make-you-a-trader-or-investor/ they cite one example in which a person didn't qualify as a trader who had traded "204 trades during 2006, 303 trades during 2007, and 1,543 trades during 2008". The 2008 year was enough, but the 2006 and 2007 year wasn't. But what is the minimum number of trades per year one would need to qualify? Just as an example, lets say one buys one stock at the opening price and sells it at the closing price on the same day and repeats this each day for 252 days (the total number of trading days in a year). So there would be 252*2=504 trades in total. Would this qualify one as a trader or an investor if you did this, so that you could avoid the wash rule?

My second question is regarding starting a company. Is it necessary to start a sole proprietorship in order to qualify as a trader and avoid the wash rule?

 

[Adam E. Spence CPA]

The test for being classified a trader is heavily fact and circumstances-based. Activity and holding periods are considered. There has to exist frequent activity aimed at capturing short-term profits. Turnover is one factor. Being a trader, whether as an individual or though a sole proprietorship, in itself does not eliminate wash sales. Being classified as a trader means your expenses are deductible from gross income without limitation i.e. without the 2% floor as with being classified as an investor. Being a trader opens up the possibility for a section 475 election which eliminates the wash sale issue as all positions are marked-to-market but you lose any possibility of long-term gains and revoking the election is very difficult.

 

[ScalperJoe]

Being a trader opens up the possibility for a section 475 election which eliminates the wash sale issue as all positions are marked-to-market but you lose any possibility of long-term gains and revoking the election is very difficult.

Is it possible to have TWO separate retail accounts (one for trading, one for long term investing), and only specify the mark-to-market for the trading account?

 

[Adam E. Spence CPA]

It is less common that a 475 election is made at the individual level. It is usually seen within an LLC. That way, if the 475 election no longer makes sense, simply dissolve the LLC as the 475 election is difficult and expensive to revoke. Normally, within the context of an individual, the election applies to all accounts with the option to specifically identify non-475 positions i.e. long-term holdings for which long-term rates could apply. The best method to accomplish this identification is by holding those positions in an account titled to the effect of "non-475 account". That being said, I have seen a 475 election which excluded trades under section 1092 which would suggest that there is some flexibility to craft the election is such a fashion that it only applies to the trade or business of scalping; provided there are separate accounting records and other facts to indicate it is a trade or business as defined by the Internal Revenue Code. I'm not saying it isn't possible, just that I haven't seen it. Hope this helps.

 

[Robert A. Green]

See how to qualify for trader tax status on our website here http://www.greentradertax.com/trader-tax-center/trader-tax-status/how-to-qualify/. Follow our golden rules and watch our related webinar recording.

If you qualify for all or part of the year 2014 you can file a schedule C with trading business expenses and home office deductions.

You're stuck with capital gain loss treatment and wash sale loss reporting unless you made a section 475 MTM election on time and qualify for trader tax status so you can use it. The 475 election was due by April 15, 2014 for existing individual taxpayers.

 

[Robert A. Green]

Is it possible to have TWO separate retail accounts (one for trading, one for long term investing), and only specify the mark-to-market for the trading account?

Caution the rules for segregation of investments from business trading positions with 475 are nuanced and severe if you don't follow them well.

Read our blog post IRS warns 475 traders http://www.greentradertax.com/irs-warns-section-475-traders/

A taxpayer does not elect 475 on an account per se. A taxpayer elects 475 - on perhaps securities not futures - across all of taxpayers accounts and it doesn't apply to duly segregated investment positions in form and substance. We've had some very interesting cases that we've argued for clients on this subject with the IRS and states.

You can designate an account an investment account but just make sure that it acts accordingly and you don't trade substantially-identical positions in your trading account. Substantially identical means between stocks and options. You can't hold Apple in your investment account and trade Apple options in your trading business account with 475.

 

[Adam E. Spence CPA]

Generally speaking, the 475 election can be written in such a fashion that only the trade or business of trading is marked-to-market. The key is in the wording of election statement.

 

[Robert A. Green]

Hi Adam, I'm not sure what you mean here, but thanks for your contributions to the elite trader thread.

A taxpayer elects Section 475 MTM accounting on all their trading business. Of course it does not apply to duly segregated investments. They can elect and have a single-member LLC disregarded entity with 475 and must use 475 on a sole prop trading business run through another trading account. There is no way to carve out one business with 475 versus another without it all within the same taxpayer ID.

 

[Adam E. Spence CPA]

Hi Robert,

You are correct - it applies to the trade or business of trading, not all accounts. Specifically, 475(f)(3) indicates that the (f)(1) or (f)(2) election "may be made for each trade or business". It is possibly to have such a carve-out though there is no clear statutory authority for it. Specialty-475 elections by default carry limited case history and authority however if the fact pattern supports the election, it generally will stand. This potential carve-out is generally only an issue when a 475 election is made at the individual level whether or not through a disregarded entity. A separate regarded LLC or LP is the best means for executing a 475 election. If the strategy which prompted the need for such an election no longer works, simply dissolve the regarded entity. Revoking the election at the individual level is more difficult.

 

[Robert A. Green]

Not sure we agree here. We consider a SMLLC disregarded entity a "tax nothing" so a SMLLC disregarded entity 475 election is an individual election. An individual has one trading business with trader tax status, not two.

Adam, I suggest a private conference call with you, my partner Darren Neuschwander, our tax attorney Mark Feldman and me soon. If interested, please let me know. Let's get acquainted and compare notes on this subject. Thanks.