Robert A. Bonavito, CPA PC

Utilizing Section 475 F of the IRS Code

Investors vs. Traders

The IRS has many factors they will consider if you are classified as an investor/trader.

  1. The holding period for securities bought and sold
  2. The frequency and dollar amount of your trades during the year
  3. The extents which you pursue an activity to produce income for a livelihood
  4. Amount of time you devote to the activity

Investors follow the basic rules of capital gains and losses, they report this information on schedule D.

Even though most traders operate like a business, they still do not have inventory or customers. Therefore, their gains or losses on sales of security are still treated as capital gains and capital losses and are recorded on schedule D. It is important to note that if you are a trader your expenses are treated differently than an investor.

Your margin interest is not limited as a deduction and you can write off all of your business expenses such as management fees, investment newsletters, courses, travel, education etc. Generally, these expenses can be deducted on schedule C or the business that you set up.

It is also important to note that traders are not subject to Social Security Tax on the earnings. This is because dividends interest from securities and gains and losses from the sale of capital assets are not considered self-employment income.

If, however, you make the Section 475(f) election you can then take advantage of the Mark to Market treatment of your investments. The big benefit here is that at year-end you look at every position you have and treat it as if it was sold. You will then compare all of your holdings at year-end values to what you paid for them and calculate your gain and loss.

If for example you have a loss you can deduct that from your ordinary income. If you have a gain you have to pay income tax on that gain.  

Once you understand section 475(f) election you may want to consider making it if you truly are a trader. In order to make the election you have to attach a statement to your tax return indicating that you want to make a section 475F election. The election has to be made with the filing of your return in order to be valid.

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