Professional Day Trading – Mark to Market
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Day-trading can be a lucrative way to earn some extra income or even a full-time living. If you are serious about day-trading you need to get serious about how you structure your trades. I’m not talking about what to buy or when you sell. I’m talking about the legal structure and accounting methods.
When day-trading you will get hit with many restrictions. The two biggest are the wash sale rule and limits on your loss carry forward (currently $3,000). If you trade substantially and have a loss of $15,000, it would take you 5 years to fully deduct your losses if you don’t have the right structure.
Our goal is to be able to use mark-to-market accounting for our trading.
Taxpayer businesses that maintain a complete set of accounting books and records which qualify under IRS Reg. 1.4461(d)(1) may elect trader status in advance and use mark-to-market method of accouning. This treats what you would normally file as Schedule D capital gains/losses as Form 4797 ordinary gains/losses.
Mark-to-Market Characteristics
+ Losses are not limited (currently limited to $3,000 current year loss, rest must be carried forward $3,000 at a time.
+ Securities are not subject to wash sale rule. This is big as sometimes you will want to get in and out of the same stock in a short-period of time.
+ Paper losses at the end of the year are deductible.
- Paper gains at the end of the year are taxable.
- Gains in securities held over 12 months are not taxed at lower long-term capital gains rates.
- Old capital loss carry forwards will be stuck on Schedule -D.
Filing to get Mark-to-Market
Step 1 – Form a company
The safest way to avoid IRS scrutiny is to not file as an individual choosing trader status. Create an LLC that will be the owner of your brokerage accounts that are used for trading. The company will elect mark-to-market accounting. So step 1 is to form an LLC.
Step 2 – Make the election
File your election on or before April 15, 2008 with either your tax return or extension request. It must be attached to one or the other. You can not send it seperately. This is explicitly stated in the IRS rules.
Below is what an election would look like:
MyCorp, LLC [Enter your company name]
12-3456-789 [Enter your company Tax ID Number (TIN)]
Attachment to 2007 Form 1040I hereby elect to use the mark-to-market method of accounting under section 475(f) of the Internal Revenue Code for my trade or business of trading securities. The first year for which this election is effective is the taxable year commencing January 1, 2008.
John Doe
President (or other company rep)
MyCorp, LLC
Step 3 – File the election/Form 3115 with your 2008 tax return
When you file your return for the year the election is effective you must attach Form 3115. Also send a copy to the IRS National office. You will also need to attach a statement with the form like below.
MyCorp, LLC [Enter your company name]
12-3456-789 [Enter your company Tax ID Number (TIN)]
Attachment to Form 3115In accordance with Rev. Proc 99-17 and section 475(f) of the Internal Revenue Code, the taxpayer filed an election with his 2008 income tax return to use the mark-to-market method of accounting in connection with his trade or business of trading securities, effective beginning with the taxable year beginning January 1, 2008 and onwards. This method will be used for the taxpayer’s books and records and financial statements.
That’s it. Now you can focus on making money and not have to worry about the wash sale rule and limited loss carry forwards. In fact if you have a loss this year you can amend your prior 2 tax returns to offset the income and get a refund!
Disclaimer: I am not a C.P.A. or lawyer. Please consult with your C.P.A. or lawyer when dealing with tax & legal matters.
8 Comments on this post
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Dan said:
Interesting, I always knew an LLC was a good way to work with taxes and trading but not to that extent.
Out of curiosity, do you have an LLC? I’ve been thinking of creating one but don’t really know too much more about it as far as the legal issues go.
January 11th, 2008 at 11:48 am -
Dax Desai said:
Yes I have one. It is very easy to create an LLC. There are many websites that will do it for you or just find a reasonably priced attorney that can draft it for you. In Texas we can file ours online directly with the secretary of state and receive our LLC within 24hrs.
January 12th, 2008 at 12:56 am -
Mark said:
Awesome, thank you!
I work with traders who use mark to market, and I had them try to explain it to me on numerous occasions. No one before explained it to me as clearly as you have. Thanks for the Step by Step, Laterz!
P.S.
Maybe financials now? hehe.. they fell thru the bottom of the previous trading range, but might settle here, and there is lots of room for retracementJanuary 12th, 2008 at 4:41 pm -
Dax Desai said:
Mark – Thanks for the good words.
As for financials… I watched them, GS in particular. I bought 2 Feb $200 calls at $8.60 and sold at $9.50 for a $178.50 2 day gain on a $1721.50 investment. My commissions were $1.50 buying and $1.50 selling so net $178.50 all said and done.
I do think there is some downside trading opportunity with this stock for now. I also think it is getting close to longability. Is that a word? It is now.
January 12th, 2008 at 7:58 pm -
Ray B. said:
Dax-
Do you happen to know if an existing business (s-corp) can be used for trading and filing for 2008 trader status if the existing business does not deal with finance at all? Does IRS need to be informed of this? I don’t want to create a new corporation since I already have my consulting business and need a trader status also. I am also not sure of how to pay salary etc. etc. if you are a trader, any comments?.
Great blogs—Thanks!
/Ray
January 13th, 2008 at 4:43 pm -
Dax Desai said:
Ray B –
I definitely understand not wanting to create another company. However I must caution you. When making the election you are saying that is your main source of income – trading. Now if you have a consulting business, let’s say you have $100K of income from that and $40K of income from trading. The IRS may argue that your main source of income is not trading and that it is not your main line of business. However if you had a seperate entity and all it did was trading, the IRS would not be likely to win that argument. I know it is quirky, but the statistics indicate that it is much safer to do it that way.
Consider the costs and benefits. Again – I’m not a tax attorney, I just play one on this blog. Just kidding. Seriously though make sure you take everything under consideration. A great company that does the whole process is tradersaccounting.com. All they do is accounting for traders. They also do the incorporation. I haven’t used them, but a colleague of mine has and their incorporation work/consulting is the best I’ve seen. The fact that they focus on the trader makes sure they have the best work for a trader as opposed to a generic lawyer.
Good luck Ray and always feel free to ask a question. It tickles my brain and keeps the neurons active.
January 14th, 2008 at 11:38 am -
Jose said:
Hi, when picking mark to market, if I already filed my taxes, can I still select mark to market? So the reason to select mark to market is because in case you have another job u want to say that trading is your main source of income? and then, what if i do have a job and want to part time trade is it necesarry to file mark to market? I know this are questions for an accounting firm, but, I asked an accountant yesterday and he didn’t say much of me trying to form an LLC to use as my trading company. If i start trading without picking mark to market and dont have an LLC and have another job, what will the IRS reaction be or how can i handle the IRS?
April 8th, 2008 at 12:28 pm
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