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Trader Tax Considerations
Over the past several years, retail investing has undergone a dramatic transformation. What was once the exclusive domain of institutional players has opened up to everyday individuals. This shift has been fueled by a combination of powerful forces—advances in technology, commission-free trading platforms, the rise of meme stocks, the explosion of cryptocurrency, and the ripple effects of COVID-19 on market behavior.
With more people participating in the markets than ever before, it’s critical to understand how the IRS views different types of market participants—especially when it comes to taxes. In this post, we’ll break down the three primary investor classifications recognized by the IRS, and then dive deeper into what it means to qualify as a “Trader” for tax purposes, including the key elections and benefits that status can unlock.
Types of Investors
In the eyes of the IRS you are considered either an investor, dealer, or trader.
| Taxpayer | Taxpayer Description | Tax Reporting | Tax Considerations |
| Investor | Investors buy and sell securities primarily to earn income from dividends, interest, or long-term capital gains. Their activity is for personal investment rather than a business, and they typically hold assets for extended periods to achieve long-term growth. | Sales result in capital gains and losses reported on Schedule D (Form 1040), Capital Gains and Losses and on Form 8949, Sales and Other Dispositions of Capital Assets as appropriate. | Investors face capital loss limitations under section 1211(b) and must follow wash sale rules under section 1091. While commissions and related costs aren’t deductible, they must be included when calculating gains or losses on the sale of securities. |
| Dealer | Dealers are individuals or entities that actively buy and sell securities with customers as part of their regular business operations. They engage in these transactions routinely in the ordinary course of their trade or business | Gains and losses are reported on Part II of Form 4797, Sales of Business Property. Business expenses are reported on Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship). | Dealers must report gains and losses associated with securities by using the mark-to-market rules. |
| Trader | To qualify as a trader, one must actively seek profits from daily market price movements, not from dividends or long-term gains. The trading activity must be substantial, and it must be conducted with continuity and regularity. | Traders report business expenses on Schedule C, but like investors, they can’t deduct commissions directly—they must include them in the gain or loss calculation on Schedule D and Form 8949. Their gains and losses are also not subject to self-employment taxes. | If 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 and Form 8949, as appropriate. Both the limitations on capital losses and the wash sales rules continue to apply. |
| Trader (Mark-to-Market Election) | The election is made 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. 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, Section 24.01, by filing a Form 3115, Application for Change in Accounting Method. Furthermore, revocation of election requires IRS approval. | Ordinary gains and losses are reported on Part II of Form 4797, Sales of Business Property. Business expenses are reported on Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship). | 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)) and income may qualify for the QBI deduction. |
Qualifying as a Trader
Qualifying as a “Trader” is not a bright line test. As a result, tax advisors and taxpayers have been relying on historical case law. Based on these cases, the IRS and courts consider several factors listed below when determining trader status. It’s important to note that no single factor is determinative; the IRS and courts assess the totality of circumstances.
- Frequency and Volume: Executing hundreds of trades per year, spread consistently throughout the year.
- Holding Period: Short-term holding periods, typically less than 31 days.
- Continuous Activity: Trading activity on most trading days, aiming for at least 75% of available trading days.
- Intention to Profit from Short-Term Market Movements: The primary goal should be to profit from daily market fluctuations, not long-term appreciation or dividends.
Conclusion
Qualifying as a trader for tax purposes requires more than just active investing—it demands a documented, consistent, and short-term trading strategy. If you’re uncertain whether your trading activity meets the IRS requirements, don’t hesitate to reach out to us for personalized guidance.
Disclaimer: The information provided herein is intended solely for informational purposes and no person(s) or other third-party may rely upon it as financial, tax, or legal advice or use it for any other purposes. As a result, Royal Financial, and any affiliates, assume no responsibility whatsoever to readers, or any other persons for that matter, as a result of the information contained herein.