Day Trading Tax Secrets

Generally speaking, the IRS recognizes two kinds of sales: Capital gains and losses, which are the ordinary gains and losses experienced by most investors, and the sale of business inventory, which is frequently considered income. As a day trader, you may have the option to treat your investment activity as a business, which holds a number of tax advantages for you.

Claim Status as a Trader

Trader status differentiates you from the buy and hold investor, in that the IRS recognizes that you run your day trading activity as a business. Like any other business, status as a trader will allow you to deduct the full amount of any business expenses; you don't have to worry about your itemized deductions exceeding 2 percent of your income. Claim your business expenses on a Schedule C. Further, while investors cannot deduct capital losses against more than $3,000 of income in any given year, you as a trader may be able to offset all your losses against your income, provided you elect the mark-to-market accounting option.

To qualify for trader status, you will have to meet a number of strict requirements: You must demonstrate that you seek to profit from daily price swings in the market, that your trading activity is substantial, and that you trade on a near-daily basis. In essence, you must show the IRS that day trading is your job. The IRS may also require you to document all your trades for the tax year.

Provided you qualify for trader status, selecting mark-to-market accounting (MTM) allows you to deduct unlimited losses against income. To elect mark to market, submit IRS Form 3115 with your tax return. Be sure you are strictly segregating all your investment holdings -- that is, your long-term assets -- away from your day trading inventory. Otherwise you could get socked with income taxes on gains in securities you haven't even sold.

If you qualify for trader status, file your profits and losses from trading on form 4797, Sales of Business Property. This is because the IRS considers your securities to be business inventory rather than investment property.