Tax Tips for Day Traders

How day trading affects your taxes: What you need to know

Whether you're thinking about day trading or already doing it, you should know that this will likely impact your taxes. We’ll give a broad overview of what you may expect and some key terms you may encounter.

It shouldn’t come as a surprise that you must pay taxes on your earnings, which cuts into any potential profit. Additionally, day trading doesn't qualify for favorable tax treatment compared with long-term buy-and-hold investing. But there are other advantages.

What’s the difference between day trading and long-term investing?

Before we dive in, let’s explore how these two types of investing differ. Day trading is buying and selling on small price movements during a trading day, often in the matter of seconds or minutes. Long-term investing is buying and then selling after a long period of holding an investment while waiting for the right price. Most often, people do long-term investing through retirement vehicles like your 401k or IRA.

How to qualify for trader tax status

If you treat your day trading as a business and you meet certain IRS requirements to be considered a "trader in securities," you can reduce some tax impacts. Any net profits may be subject to self-employment tax, which also comes with some advantages.

For everyday investors who don’t qualify as a day trading business, the following rules may apply:

• You're required to pay taxes on investment gains in the year you sell.
• You can offset capital gains against capital losses, but the gains you offset can’t total more than your losses.
• You can use up to $3,000 in excess losses per year to offset your ordinary income, such as wages, interest, or self-employment income on your tax return and carry over any remaining excess loss to following years.
• If investments are held for a year or less, ordinary income taxes apply to any gains.
• Holding an investment for more than a year usually allows traders to take advantage of lower long-term capital gains tax rates.
• Capital gains distributions and dividend distributions—the money you make on your investments—require you to pay taxes in the year you take these distributions.
• Investors may avoid or defer these taxes by holding their investments in a tax-advantaged account, like a 401k or IRA.

What are capital gains and is it taxed?

Capital gains tax is a tax on your investing profits. Here’s how it works. Almost everything you own and use for personal or investment purposes is a capital asset. Examples include a home, personal-use items like household furnishings, and stocks or bonds held as investments.

When you sell a capital asset, the difference between what you bought it for and what you sold it for is the amount of capital gain or loss.

Broadly speaking, you have a capital gain if you sell the asset for more than you paid for it. You have a capital loss if you sell the asset for less than you paid for it.

What’s the difference between short-term and long-term capital gains?

To correctly arrive at your net capital gain or loss, capital gains and losses are classified as long-term or short-term. This is where the length of time you hold onto an asset really matters.

In general, if you hold the asset for more than one year before you sell it, your capital gain or loss is long term. If you hold it for one year or less, your capital gain or loss is short term. For exceptions to this rule, such as property and securities received by gift, property bought from a decedent, or patent property.

To figure out how long you held the asset (in this case, a security), you generally count from the day after you bought the asset up to and including the day you sold the asset.

If you have a net capital gain, a lower tax rate may apply to the gain than the tax rate that applies to your ordinary income. The term "net capital gain" means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss for the year.

Capital gains tax rates

The tax rate on most net capital gain is no higher than 15% for most individuals. You may not need to pay capital gains tax if your taxable income is less than or equal to $44,625 for single and married filing separately, $89,250 for married filing jointly or qualifying surviving spouse, or $59,750 for head of household. Below, we explore how rates apply to different income thresholds. A capital gain rate of 15% applies if your taxable income is:

• More than $44,625, but less than or equal to $492,300 for single;
• More than $89,250, but less than or equal to $553,850 for married filing jointly or qualifying surviving spouse;
• More than $59,750, but less than or equal to $523,050 for head of household, or more than $4,625, but less than or equal to $276,900 for married filing separately.

However, a net capital gain tax rate of 20% applies if your taxable income exceeds the thresholds set for the 15% capital gain rate that we outlined above.

There are a few other exceptions where capital gains may be taxed at rates greater than 20%:

• The taxable part of a gain from selling section 1202 qualified small-business stock is taxed at a maximum 28%
• Net capital gains from selling collectibles (such as coins or art) are taxed at a maximum 28%
• The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25%

It’s important to note that net short-term capital gains are subject to taxation as ordinary income at graduated tax rates.

Limit on the deduction and carryover of losses

If your losses exceed your gains, you have what’s called a capital loss. You can deduct some or all of it from your taxes. Depending how great your losses are, you may need to spread out your deductions over to later years. Here’s how that works.

Capital losses that exceed capital gains in a year may be used to offset ordinary taxable income up to $3,000 in any one tax year. Net capital losses in excess of $3,000 can be carried forward indefinitely until the amount is exhausted.

You can use the Capital Loss Carryover Worksheet to figure the amount you can carry forward. Your Tax Pro can work with you on this, as it can be very complex.

What forms do I use to report capital gains?

You’d report most sales and other capital transactions and calculate capital gain or loss on Form 8949, Sales and Other Dispositions of Capital Assets, then summarize your capital gains and deductible capital losses on Schedule D (Form 1040), Capital Gains and Losses. Your Tax Pro can help you with what to do and what forms to use.

Estimated tax payments

If you have a taxable capital gain, you may be required to make estimated tax payments throughout the year. Work with your Tax Pro to figure out what you may owe.

How does the mark-to-market method work?

A mark-to-market election allows a trader to “sell” their stocks at the end of each year. This is done by using the value of the stock on that day and reporting those sales on Form 4797, Sale of Business Assets.

The benefit of using mark-to-market is that it can give you a more accurate figure for the current value of your assets, based on what you may receive in exchange for the asset under current market conditions. On the flip side, if there is a lot of market volatility, it may make it hard to value your assets.

A trader must make the mark-to-market election by the original due date (not including extensions) of the tax return for the year prior to the year for which the election becomes effective.

You and your Tax Pro can make the election by attaching a statement to your income tax return, if filed in a timely manner. This can get complicated quickly, and a Tax Pro would be able to help with the ins and outs.

What is the wash sale rule?

The wash sale rule means that if an investment is sold at a loss and then repurchased within 30 days before or after the sale, you cannot claim the initial loss for tax purposes. The 30 days on either side of the sale, plus the day of the sale, translates into 61 days of what is called a “wait period.” This is the time during which you cannot buy the same or similar security. 

A wash sale also results if an individual sells a security or stock, and the individual's spouse or a company controlled by the individual buys the same or similar security during the 61-day wait period.

The point of the rule is to prevent investors from creating an investment loss for the benefit of a tax deduction, while essentially maintaining their position in the security.

When reporting on Schedule D, both the limitations on capital losses and the wash sales rules continue to apply. However, if you make a timely mark-to-market election, then you can treat the gains and losses from sales of securities as ordinary gains and losses, except for securities held for investment. Neither the limitations on capital losses nor the wash sale rules apply to traders using the mark-to-market method of accounting.

Does the wash sale rule apply to cryptocurrency?

The IRS wash sale rule does not currently apply to cryptocurrency, because it considers virtual currencies to be property rather than securities. That said, every year the IRS reassesses the tax code and rules to keep up to date with inflation, new technology and other changes. Always check with your Tax Pro about any questions you may have.

Business expense deductions

The Qualified Business Income (QBI) deduction is one of the most common tax write-offs for self-employed workers. If you’re day trading as a self-employed person, you may qualify.

For tax year 2023 (filed in 2024), you can take this type of deduction if your taxable income falls below $182,100 for individuals, or $364,200 for joint returns and certain taxpayers with higher business income.

QBI is income from a trade or business in the U.S. The QBI deduction does not include wages earned as an employee and business-generated capital gains, interest, and dividend income.

According to the IRS, deductible business expenses for taxes must be both necessary and ordinary. That means the expense must be:

• Common and accepted in your business or trade
• Appropriate and helpful for your business or trade

Deductible business expenses may include the cost of goods sold, capital expenses, and other expenses. Keep the following potential business expenses for taxes in mind and save your receipts and records throughout the year to maximize your self-employment deductions and always keep the records of any trades you make throughout the year.

We’ve gone through some basics about day trading in this piece, but there is a lot more nuance and detail to cover. Always work with your Jackson Hewitt Tax Pro on any questions you may have. We’re here to help year-round. Find one near you today.

About the Author

Mark Steber is Senior Vice President and Chief Tax Officer for Jackson Hewitt. With over 30 years of experience, he oversees tax service delivery, quality assurance and tax law adherence. Mark is Jackson Hewitt’s national spokesperson and liaison to the Internal Revenue Service and other government authorities. He is a Certified Public Accountant (CPA), holds registrations in Alabama and Georgia, and is an expert on consumer income taxes including electronic tax and tax data protection.

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