Trader Tax Status: What Is It and How to Qualify?

The Internal Revenue Service (IRS) categorizes individuals who buy and sell securities as either investors or traders. This classification dictates how gains, losses, and expenses are reported for tax purposes. Individuals who trade frequently and substantially may qualify for Trader Tax Status (TTS), which provides tax treatments unavailable to a typical investor. This status is not an election but is determined by a “facts and circumstances” test based on the nature of the trading activity.

Qualifying for Trader Tax Status

Qualifying for Trader Tax Status is not a simple declaration but a status earned by meeting a set of criteria established by the IRS and upheld by tax courts. There is no single, definitive rule, but rather a collection of factors that demonstrate the operation of a securities trading business. The determination relies on the facts and circumstances of an individual’s trading activity, and the burden of proof rests on the taxpayer.

A primary factor is the volume and frequency of trades. The activity must be substantial, often interpreted as hundreds of trades annually, with some practitioners suggesting a benchmark of at least 720 trades per year. Trading must also be frequent and continuous, occurring on a near-daily basis. A common guideline is executing trades on at least 75% of available market days, as sporadic activity does not meet this standard.

Another element is the holding period for securities. A trader’s primary motive is to profit from short-term price fluctuations, not from long-term capital appreciation or dividends. This intent is reflected in short holding periods, often lasting only days or weeks. An average holding period of 31 days or less is a widely recognized test to distinguish a trader from an investor, who holds securities for months or years.

The amount of time and effort dedicated to the activity is also examined. A taxpayer seeking TTS should spend several hours per day on their trading business. This time includes researching, planning, and managing the operational aspects of the business. The activity should be pursued to produce income for a livelihood, and maintaining records of time spent and business-like operations can substantiate the claim.

Tax Implications of Trader Status

Achieving Trader Tax Status without a mark-to-market election creates a hybrid tax situation where gains and losses from selling securities remain capital gains and losses. They are reported on Schedule D and Form 8949, just as they are for an investor.

The main advantage is the ability to deduct business-related expenses. Unlike an investor, whose investment-related expenses are not deductible, a trader can deduct ordinary and necessary business expenses on Schedule C, “Profit or Loss from Business.” These deductible expenses can include:

• Margin interest
• Subscriptions to financial data feeds and news services
• Charting software
• Computer hardware
• Professional fees for tax advice
• Educational expenses related to trading

If a trader maintains a dedicated space in their home exclusively for the business, they may also claim a home office deduction.

Net income from trading is not subject to self-employment tax. While expenses are reported on Schedule C, the capital gains are not considered earnings from self-employment. This means the trader is not required to pay Social Security and Medicare taxes on trading profits, a notable distinction from most other sole proprietorships that report income on Schedule C.

The Mark-to-Market Election

Taxpayers with TTS can make a mark-to-market (M2M) election under Internal Revenue Code Section 475. With this election, a trader treats all securities in their trading portfolio as if they were sold for fair market value on the last business day of the year. This “deemed sale” means the trader recognizes all unrealized gains and losses annually. The basis of these securities is then adjusted to their year-end market value to prevent double-taxing the same gain or loss in the future.

The most significant consequence of an M2M election is the conversion of capital gains and losses into ordinary gains and losses. While gains are taxed at ordinary income rates, which can be a disadvantage, the treatment of losses becomes highly advantageous. Ordinary losses are not subject to the $3,000 annual capital loss limitation and can be used to fully offset other ordinary income, such as wages.

Another benefit of the M2M election is the exemption from the wash sale rule. This rule normally disallows a loss on a security sale if a substantially identical one is bought within 30 days before or after the sale. For active traders, this rule can be a significant bookkeeping burden and can lead to the deferral of substantial losses. Making the M2M election removes this requirement for trading activities, allowing for the immediate recognition of all losses.

Making the Mark-to-Market Election

The M2M election is time-sensitive. For an existing taxpayer, the election must be made by the original due date of the tax return for the year prior to the year the election becomes effective, not including extensions. For example, an election for the 2025 tax year must be made by the tax filing deadline in 2025 for the 2024 return. The election is made by attaching a specific statement to the prior-year tax return or to a request for an extension of time to file that return. The statement must specify the first effective tax year and identify the trade or business.

The procedure for a new taxpayer is different. A new taxpayer must place the required statement in its books and records no later than two months and 15 days after the first day of its first tax year. A copy of this statement must then be attached to the tax return filed for that initial year.

A taxpayer must also file Form 3115, “Application for Change in Accounting Method.” While the election statement is filed with the prior year’s return, Form 3115 is filed with the return for the year the change actually takes place.

Tax Treatment for Investors

Individuals who do not meet the criteria for TTS are classified as investors. For an investor, all gains and losses from security sales are capital in nature and are reported on Schedule D and Form 8949. A defining feature of investor tax treatment is the limitation on deducting capital losses. If an investor’s capital losses exceed their gains, the net loss that can offset other income is limited to $3,000 per year, or $1,500 for married filing separately status. Any excess losses are carried forward to future tax years.

The tax treatment of expenses also differs for investors. Following the Tax Cuts and Jobs Act of 2017, most investment-related expenses are no longer deductible for individuals. This includes costs such as investment advisory fees, subscriptions to financial publications, and software used for managing a portfolio.

One of the few remaining deductions is for investment interest expense, which is interest paid on money borrowed to purchase investments. This expense can be deducted on Schedule A as an itemized deduction, but only up to the amount of the investor’s net investment income for the year.