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Taxation & Estate Planning

DAY TRADER IS ONLY AN INVESTOR

Successful stock market day traders like to be characterized as mere investors for federal income tax purposes - this allows them to pay taxes on their trading gains at preferential capital gains rates. Unsuccessful stock market day traders want to avoid the "investor" label, and instead they want to be characterized as engaged in the trade or business of trading. This is because they don't want capital loss treatment for their trading losses - capital losses can only be used to offset capital gains (except as to $3,000 per year which can be used to offset ordinary income). Further, their trading expenses can only be deducted to the extent they and any other miscellaneous itemized expenses exceed 2% of adjusted gross income.

William Holsinger fell into the unsuccessful category, losing over $180,000 in trading activities in 2001. William claimed he was in the trade or business of trading, and sought ordinary loss treatment for his trading (even though, in 2000, when he had trading profits, he reported those as investment capital gains). He also sought ordinary loss treatment for losses incurred in 2002. The IRS disallowed the ordinary loss treatment, indicating that Mr. Holsinger's trading activities were insufficient to give rise to trade or business status.

To determine whether a trade or business exists for trading activities, the courts look at the taxpayer's investment intent and the frequency, extent, and regularity of the taxpayer's securities transactions. More particularly as to stock market trading activities, a taxpayer's stock market activities constitute a trade or business if the trading is substantial, and the taxpayer seeks to catch the swings in the daily market movements and to profit from these short-term changes rather than to profit from the long-term holding of investments.

Mr. Holsinger's trading activities were somewhat substantial - in 2001, Mr. Holsinger conducted 289 trades. In 2002 he conducted 372 trades.

However, in neither year did he trade on more than 45% of the available trading days. Further, Mr. Holsinger rarely bought and sold the same securities on the same day, and held many stocks for more than 31 days at a time. As such, it was difficult to show that he was seeking to capture "daily" market movements, as opposed to seeking to capture profits from more long-term market movements.

Ultimately, the Tax Court held that his trading activities were not sufficient to get out of investor status, in large part due to the extended holding period of many of his purchases (i.e., more than one day).

Holsinger v. Comm., TC Memo 2008 ?191

Full post as published by Rubin on Tax on August 14, 2008 (boomark / email).