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Day trading stocks is a fast-paced, high-adrenaline job with huge potential rewards — and huge potential losses. It can also include some really sweet tax breaks if you qualify as a trader in the eyes of the IRS.
That’s a big “if.”
Many people who buy and sell stocks on the side — that is, they have a full-time job that doesn’t involve trading — are considered “investors” by the IRS, rather than “traders.”
Here's a day-trading tax guide that can help you navigate some common issues that traders encounter — and a handful of tips that may help you manage your liabilities.
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Day-trading tax rates
Day trading taxes can vary depending on your trading patterns and your overall income, but they generally range between 10% and 37% of your profits.
Income from trading is subject to capital gains taxes. Even if you're not a day trader, you'll have to think about capital gains taxes if you make any money by buying and selling investments.
There are two types of capital gains taxes, long-term and short-term. Any investment you hold for more than a year is eligible for lower, long-term rates (these range from 0% to 20%).
But if you're buying and selling investments within the space of a day, you're probably not going to come close to that 365-day break.
Short-term capital gains tax rates
When it comes to short-term capital gains, you can use the same tax bracket you use for other income.
So if you're in one tax bracket based on your overall income for the year, you'll use that same rate for your capital gains.
» MORE: Federal income tax brackets and rates | Income tax rates by state
3 active trader tax breaks
If you qualify, you can receive some valuable tax benefits from your day trading:
Trading expense write-offs. Expenses related to trading are deductible as business expenses. This is potentially a much more valuable set of deductions than what ordinary investors can claim. For example, you can claim a home office for your business. Investors can deduct only investment expenses that exceed 2% of their (investment expenses fall under “miscellaneous itemized deductions”).
Deductions from losses. As a trader, each year you can use all of your losses to reduce your taxable income, assuming you made a Section 475 “mark to market” election with the IRS. You must make this election by the filing deadline for your previous year’s return . Investors can reduce their taxable income by a maximum of $3,000 worth of capital losses per year.
Wash-sale rule exemption. The wash-sale rule is a tough one for ordinary investors, who are prohibited from claiming a loss on a stock if they bought a “substantially identical” stock either 30 days before or 30 days after the loss sale. But active traders don't have to worry about that rule, as long as they made the Section 475 election.
Are you a day trader for tax purposes?
There’s no statute or regulation that separates traders from investors, but plenty of cases have gone to tax court. Tax experts use those cases to guide clients.
One thing is clear: It’s not easy to qualify as a trader. Even some large hedge funds have investor tax status rather than trader tax status.
You may need to contact a tax pro to determine whether you qualify as a trader with the IRS. But here are some questions to help guide your thinking:
Are you making at least four trades per day, four days per week?
Is your average holding period must be less than 31 days?
Do you spend about four hours per day working as a trader, including research and administration?
Are you treating day trading as a business, with the necessary equipment, software and research tools?
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Tax breaks for regular investors
If you don’t qualify as a trader, all is not lost. Investors qualify for tax breaks, too, including these:
You enjoy a low capital gains rate on investments held for a year or longer.
You can reduce income by up to $3,000 worth of capital losses and carry additional losses into future years.
You can deduct investment-related expenses to the extent that they’re greater than 2% of your adjusted gross income. This falls under the miscellaneous expense deduction, so other, noninvestment expenses might help push you above the threshold.
