Traders in securities (information for Form 1040 or 1040-SR filers)

This article outlines the criteria for an individual to be classified as a securities trader for tax purposes and how to report income and expenses from trading activities. It also covers the mark-to-market election under Internal Revenue Code section 475(f), which impacts how gains and losses are reported. According to section 475(c)(2), securities include stocks, certain partnership and trust interests, debt instruments, derivatives, and hedging instruments. Understanding the differences between investors, dealers, and traders is crucial for proper tax reporting.

Investors buy and sell securities with the goal of earning income through dividends, interest, or capital appreciation. These securities are held for personal investment and not as part of a business. Typically, investors hold onto their securities for an extended period. When selling, capital gains and losses must be reported on Schedule D (Form 1040) and Form 8949. Investors are subject to capital loss limitations under section 1211(b) and wash sale rules under section 1091. Transaction costs, such as commissions, are not deductible but must be included when calculating gains or losses. Additionally, investment income is not subject to self-employment tax.

Dealers in securities, as defined in section 475(c)(1), engage in buying and selling securities in the ordinary course of business with customers. They may also hold an inventory of securities. Unlike investors and traders, dealers generate income by selling securities to customers or providing market-making services. They must keep records that distinguish personal investments from business securities. Dealers report gains and losses using mark-to-market accounting as required under section 475.

A securities trader buys and sells securities for their own account as part of a business. Although traders do not have customers or maintain an inventory, they must meet specific requirements to qualify as a business:

To determine if an individual qualifies as a trader, several factors are considered, including holding periods, trading frequency and volume, income reliance, and time devoted to trading. If a taxpayer does not meet these criteria, they are considered an investor, even if they engage in day trading. Some individuals may be both traders and investors, meaning they must keep records distinguishing investment securities from trading securities. Investment securities should be held in a separate brokerage account.

Traders report business expenses on Schedule C (Form 1040). However, transaction costs like commissions are not deductible and must be included in gain or loss calculations. Gains and losses from trading activities are not subject to self-employment tax.

Securities traders can opt for the mark-to-market method of accounting, but investors cannot. If a trader does not elect mark-to-market treatment, gains and losses are treated as capital gains and losses, subject to limitations and wash sale rules, and reported on Schedule D and Form 8949.

If a trader elects mark-to-market accounting, gains and losses are treated as ordinary income and reported on Part II of Form 4797 (Sales of Business Property). This method removes capital loss limitations and wash sale rules.

To make a mark-to-market election, a trader must file a statement by the original due date of the prior year’s tax return (without extensions). This statement should include:

For new taxpayers without a prior-year return, the election must be recorded in business records within 2 months and 15 days of starting the business and attached to that year’s tax return.

Once made, a mark-to-market election is binding for that tax year. To revert to a realization method, traders must file a revocation statement under Revenue Procedure 2024-23 and submit Form 3115 (Application for Change in Accounting Method). The revocation statement must be filed by the original due date of the prior year's tax return. Late revocations are generally not permitted.

If a trader revokes a mark-to-market election within five years of making it, Form 3115 must be filed under the non-automatic change procedures, which require a user fee. Similarly, if a trader elects mark-to-market treatment within five years of revoking a prior election, they must follow the non-automatic change procedures.