Stocks (Options, Splits, Traders)
This is archived information that pertains only to the 2002 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.
I received stock as a gift from my grandparents. I am selling the stock this year. How can I figure the basis of the gifted stock?
To figure the basis of property you receive as a gift, you must know its adjusted basis to the donor just before it was given to you, its fair market value (FMV) at the time it was given to you, and any gift tax paid on it.
If the FMV of the property was less than the donor's adjusted basis, your basis for figuring gain on its sale or other disposition is the same as the donor's adjusted basis plus or minus any required adjustment to basis during the period you held the property. Your basis for figuring loss on its sale or other disposition is its FMV at the time you received the gift plus or minus any required adjustment to basis during the period you held the property.
If the FMV of the property was equal to or greater than the donor's adjusted basis, your basis for figuring gain or loss on its sale or other disposition is the same as the donor's adjusted basis at the time you received the gift. Increase your basis by all or part of any gift tax paid, depending on the date of the gift.
For further complete information, refer to Publication 17 (PDF), chapter 14, Basis of Property.
References:
When I sell shares of stock in a company that merged with the company I originally invested in, do I use the basis and holding periods based on the purchase of shares in the original company?
Usually, when you trade stock in one corporation for stock in another as part of a merger or other qualifying reorganization, you have a nontaxable exchange. The basis of the stock you received is generally the same as the basis of the old stock, increased by any dividend treated as received or gain recognized on the exchange and decreased by the value of property or money received.
You may receive cash or something of value instead of a fractional share if the number of shares of new stock doesn't divide evenly into the number of shares of the old stock. You treat this as a sale of the fractional share.
Your basis in the new stock is determined, in whole or in part, by your basis in the old stock. Your holding period for the new stock will include the holding period for the old stock, provided that the old stock was held as a capital asset at the time of the exchange. For special basis rules relating to incentive stock options and options granted under employee stock purchase plan see Revenue Ruling 80-244, in IRS 1980-2 Cumulative Bulletin at page 235.
Refer to Publication 550 (PDF), Investment Income and Expenses.
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How do I figure the cost basis of stock that has split, giving me more of the same stock, so I can figure my capital gain (or loss) on the sale of the stock?
The basis of the old shares must be allocated to the old and new shares in proportion to the fair market value of each on the date of the split. Thus, you generally divide the adjusted basis of the old stock by the number of shares of old and new stock. The result is your new basis per share of stock. If the old shares were purchased in separate lots for differing amounts of money, the adjusted basis of the old stock must be allocated between the old and new stock on a lot by lot basis.
References:
When my stock split, the stock distributed to me was different than my original shares. How do I figure the basis of the shares of the two different kinds of stock?
Usually, the company issuing the new type of stock will send you a letter explaining the tax consequences of the stock distribution, including how to calculate the basis in the two different types of stock.
If you did not get such a letter or would like further assistance, call IRS customer service at 800-829-0922 or refer to Publication 550 (PDF), Investment Income and Expense: Stock dividends under Basis of Investment Property.
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How do I calculate the cost basis of the shares that have split and are later sold from my employee stock purchase plan?
You need to determine what your basis is in the company stock on the date of the split. The new shares assume part of your basis in the company stock on that date. You must divide the adjusted basis in the old stock by the number of shares of old and new stock. The result is your basis for each share of stock.
For example, if you owned two shares of company stock with a basis in one at $30 and the other $45, and the company declares a three for one stock split, you now have six shares of stock. Three of the shares will have a basis of $10, and three will have a basis of $15.
Because this is an Employee Stock Option Plan, you may have to report some or all of the gain on the sale of this stock as ordinary income (wages).
References:
Do I report the buying of stock?
Ordinarily, you do not have to report the purchase of stock, only the sale of stock.
However, if you exercise a nonstatutory stock option, a type of stock option granted by an employer, you may have income to report in the year of exercise (the excess of the fair purchase value of the stock over the option price) if your rights in the stock are substantially vested at that time, see Publication 525 (PDF), Taxable and Nontaxable Income, for further information.
References:
How do I prepare Schedule D for various stocks when records as to the original purchase price have been lost?
If you purchased the stocks, you need to be able to determine the purchase price to establish your basis when you sell them. If you cannot establish the basis of stocks sold, the basis of that stock is the basis of the stock you acquired first. Except for certain mutual fund shares, you cannot use an average price per share to figure the gain or loss on the sale of stock.
Refer to Stocks and Bonds under Basis of Investment Property in Chapter 4 of Publication 550 (PDF), Investment Income and Expenses. For information on the basis of inherited stock, refer to Inherited Property in the same section of Chapter 4, Publication 550 (PDF), Investment Income and Expenses.
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How do I figure the cost basis when the stocks I'm selling were purchased at various times and at different prices?
If you can identify which shares of stock you sold, your basis is what you paid for the shares sold (plus sales commissions). If you sell a block of the same kind of stock, you can report all the shares sold at the same time as one sale, writing VARIOUS in the "date acquired" column of Form 1040, Schedule D (PDF). However, what you enter into the "cost or other basis" column is the total of all the acquisition costs of the shares sold.
If you cannot adequately identify the shares you sold and you bought the shares at various times for different prices, the basis of the stock sold is the basis of the shares you acquired first (first-in first-out). Except for certain mutual fund shares, you cannot use the average price per share to figure gain or loss on the sale of stock.
For more information, refer to Publication 550 (PDF), Investment Income and Expenses.
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Can the cost averaging method be used for calculating the cost basis of stocks, or is it limited only to mutual fund shares?
The average basis method may be used only for mutual fund shares that were purchased at various times for various prices if the shares are left in the custody of a custodian or agent in an account maintained for the acquisition or redemption of the shares.
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How do we show on our tax form where dividends are reinvested?
Some corporations allow investors to choose to use their dividends to buy more shares of stock in the corporation instead of receiving the dividends in cash. If you are a member of this type of plan, you must report the fair market value on the dividend payment date of the dividends that are reinvested as income on your tax return. You do not actually show that the dividends were reinvested on your return. Keep good records of the dollar amount of the reinvested dividends, the number of additional shares purchased, and the purchase dates. You will need this information when you sell the shares.
Report the dividends that were reinvested with your other dividends, if any, on line 9 of Form 1040 or Form 1040A. If your total income from ordinary dividends is over $400, you also must file either Form 1040, Schedule B (PDF) or Form 1040A, Schedule 1 (PDF).
For more information on this and other types of dividend reinvestment plans, refer to Ordinary Dividends in Chapter 1 of Publication 550 (PDF), Investment Income and Expenses.
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How do I compute the basis for stock I sold, when I received the stock over several years through a dividend reinvestment plan?
The basis of the stock you sold is the cost of the shares plus any adjustments, such as sales commissions. If you have not kept detailed records of your dividend reinvestments, you may be able to reconstruct those records with the help of public records from sources such as the media, your broker, or the company that issued the dividends.
If you cannot specifically identify which shares were sold, you must use the first-in first-out rule. This means that you deem that you sold the oldest shares first, then the next oldest, then the next-to-the-next oldest, until you have accounted for the number of shares in the sale. In order to establish the basis of these shares, you need to have kept adequate documentation of all your purchases, including those that were through the dividend reinvestment plan. You may not use an average cost basis. Only mutual fund shares may have an average cost basis.
Refer to Publication 550 (PDF), Investment Income and Expenses, and Publication 551 (PDF), Basis of Assets.
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I know the basis of stock includes the cost of the original purchase, but does it also include the value of stock acquired through a dividend reinvestment plan?
Unless you sell all of your shares at one time, your total basis, which includes both your original purchase and any purchases through a dividend reinvestment, is not the figure used to report the sale of shares. If you sell less than all of your shares at one time, you need to have kept adequate documentation of all your purchases, including those that were through the dividend reinvestment plan in order to establish the basis of the shares sold. You may not use an average cost basis. Only mutual fund shares may have an average cost basis.
When reporting the sale of shares of stocks, the basis for the calculation of gain or loss is the actual cost (plus adjustments, such as sales commissions) of those shares. If you cannot specifically identify which of your shares were sold, you must use the first-in first-out rule.
For more information, refer to Publication 550 (PDF), Investment Income and Expenses, and Publication 551 (PDF), Basis of Assets.
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Do I have to pay taxes again on the stock acquired through a dividend reinvestment plan when I sell them?
After you report the dividends as income, you have basis in the shares acquired through dividend reinvestment. When you report the sale of the shares, you will be taxed only on the amount that the sales proceeds (minus commissions) exceed your cost basis (in this case, the amount of the dividends reinvested).
References:
Would the shares acquired by stock dividends have a shorter holding period than the original shares purchased?
Yes, if they were taxable stock dividends, the holding period begins on the date the new shares were distributed by the corporation. For nontaxable stock dividends, the holding period is the same as the underlying stock.
When you purchase additional mutual shares with reinvested dividends, the dividends are generally taxable. You thus have a holding period starting on the date of the transaction, as reported in your statements, just as you do for shares that you purchase outright.
Would shares in mutual fund acquired through dividend reinvestment in prior years be long-term capital gains while shares acquired through dividend reinvestment in the year of sale be treated as short-term capital gains?
Any shares or fractional shares purchased and sold during the current tax year are short-term capital assets. For shares purchased in the year previous to the tax year to be considered long-term, the holding period must be more than one year.
References:
How do I report incentive stock options on my tax return?
If your option is an incentive stock option, you do not include any amount in your gross income at the time the option is granted, or at the time you exercise it. However, you may have income for Alternative Minimum Tax in the year you exercise. If the special holding periods are met, any income or loss from the sale of the stock is treated as a capital gain or loss. However, if you do not meet the special holding period tests, you may have compensation income when you sell the stock. For further information, refer to Publication 525 (PDF), Taxable and Nontaxable Income and Form 6251 (PDF), Alternative Minimum Tax-Individuals.
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How do I report a nonstatutory stock option on my tax return?
If you are granted a nonstatutory stock option, the amount of income to include and the time to include it depend on whether the fair market value (FMV) of the option on the grant date can be readily determined. For Specific information and reporting requirements, refer to Publication 525 (PDF), Taxable and Nontaxable Income.
References:
How do I report an employee stock purchase plan on my tax return?
If your stock option is granted under a qualified employee stock purchase plan, you do not include any amount in your gross income as a result of the grant or exercise of your option. When you sell the stock that you purchased by exercising the option, you may have to report either compensation or capital gain or loss. For additional information on tax treatment and holding period requirements, refer to Publication 525 (PDF), Taxable and Nontaxable Income.
References:
How do I determine the cost basis of stock bought through an employee stock purchase plan (ESPP)?
Your starting basis is what you paid to buy the shares. This amount is increased by the compensation income amount, if any, you must declare on your income tax return when the stock is sold. Sales commissions can also increase the basis in your stock but will not affect the amount of compensation that must be declared.
Under the employee stock purchase plan rules, if you had an option to purchase the stock at a discount, the amount of compensation income realized when you sell the stock depends on whether holding periods are met and whether you purchased the stock at a discount.
To satisfy holding periods, you must hold on to the stock for at least one year after its transfer to you upon purchase and for two years after the option is granted. If either of these are not true, then you have not met the required holding periods.
If the holding periods are met, the compensation income is the lesser of:
- the amount by which the fair market value of the stock at the time you are granted the option exceeds the option price, or
- The amount by which the fair market value of the stock at the time you sell it exceeds what you paid for it.
If they are not met, the compensation income is the amount by which the fair market value of the stock, when vested, exceeds what you paid for it. The compensation income should be included as wages on your Form W-2.
For more information, refer to Publication 525 (PDF), Taxable and Non-Taxable Income.
References:
I received an incentive stock option from my company, is this taxable?
If your option is a qualified incentive stock option, you do not include any amount in your gross income at the time the option is granted, or at the time you exercise it. However, you may have income for Alternative Minimum Tax in the year you exercise. If the special holding periods are met, income or loss from the sale of the stock is treated as a capital gain or loss. However, if you do not meet the special holding period tests, you may have compensation income. For further information, refer to Publication 525 (PDF), Taxable and Nontaxable Income
References:
I purchased stock from my employer under an employee stock purchase plan. Now I have received a From 1099-B from selling it. How do I report this?
If the special holding periods are met, generally treat gain or loss from the sale of the stock as capital gain or loss. However, you may have compensation income if:
- The option price of the stock was below the stock's fair market value at the time the option was granted, or
- You did not meet the holding period requirement, explained next.
You must hold the stock for more than 2 years from the time the stock option is granted to you and for more than 1 year from when the stock was transferred to you. If you meet the holding period requirement and the option price was below the fair market value of the stock at the time the option was granted, you report the difference as compensation income (wages) when you sell the stock. Generally, this compensation income cannot be more than your gain on the sale. If your gain is more than the amount you report as compensation income, the remainder is a capital gain reported on Form 1040, Schedule D (PDF). If you sell the stock for less than the amount you paid for it, your loss is a capital loss.
For more information, refer to Publication 525 (PDF), Taxable and Nontaxable Income, and Publication 551 (PDF), Basis of Assets.
References:
Where on the tax return do I enter the compensation income I had from the sale of stock that I purchased under my employer's stock purchase program?
The compensation income is reported on line 7 (wages, salaries, tips, etc.) of Form 1040. It is added to the stock's basis used when determining capital gain or loss on the sale of the stock. Any capital gain or loss on the stock sale is reported on Form 1040, Schedule D (PDF), Capital Gains and Losses.
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Is the Internal Revenue Code limit of $25,000 per calendar year for stock bought through an employee stock purchase program (ESPP) based on the discounted purchase price or the higher stock value?
Under the terms of an employee stock purchase plan, you cannot accrue the right to purchase more than $25,000 of stock, valued at market value on the day the option is granted, in any one calendar year. The limit is not based on the purchase price.
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Are incentive stock options subject to alternative minimum tax, and if so, how do I determine the basis for the stock?
A taxpayer generally must include in alternative minimum taxable income the amount by which the price he paid for stock received pursuant to the exercise of an incentive stock option is exceeded by the stock's fair market value at the time his rights to the stock are freely transferable or are not subject to a substantial risk of forfeiture.
Increase your alternative minimum tax basis by the amount of the adjustment. Your basis for regular tax is not affected by the adjustment.
If a taxpayer acquires stock pursuant to the exercise of an ISO and disposes of the stock in a disqualifying disposition in the same taxable year, the transaction is subject to regular tax, and the alternative minimum tax does not apply. Refer to Internal Revenue Code 83, Internal Revenue Code 56(b)(3), and Internal Revenue Code 422(c)(2). For more information, refer to Instructions for Form 6251, Alternative Minimum Tax- Individuals.
References:
- Instructions for Form 6251, Alternative Minimum Tax- Individuals
- Internal Revenue Code 83
- Internal Revenue Code 56(b)(3)
- Internal Revenue Code 422(c)(2)
Can I take a long-term capital loss (up to the $3,000 limit) against my ordinary income without any long-term capital gain?
Yes. The $3,000 capital loss limitation refers to how much net capital loss can offset ordinary income on your tax return.
For more information on capital gains and losses and capital loss carryovers, refer to Chapter 4 of Publication 550 (PDF), Investment Income and Expenses.
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Can I use a long-term capital loss carried over from a prior year to offset a short-term capital gain?
A loss carryover maintains its character as long-term or short-term and must first be used against gains, if any, in its own category, but can then offset net gains from the other category, as well as up to $3,000 of ordinary income. If, for example, your only gain or loss is the long -term capital loss carryover, then line 17 of Form 1040, Schedule D (PDF), which nets the net short-term gain or loss against the net long-term gain or loss, will apply your loss carryover against your short-term gain. After that, any remaining net loss will be allowable as a deduction against up to $3,000 of your ordinary income. The remainder will be available to be carried over to the following year as long-term loss.
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Can I use a long-term capital loss to offset a short-term capital gain before using it to offset a long-term gain?
No, long-term capital gains and losses must first be combined to arrive at net long-term gain or loss before the result can be netted against the net short-term gain or loss. If you follow the Form 1040, Schedule D (PDF), Capital Gains and Losses, Parts 1 and 2, line-by-line, the form will perform the netting for you in this order.
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Can short-term capital gains be offset with long-term capital losses?
Before a loss from one category, short or long term, can offset gain from the other category, the losses and gains from each category must be combined to arrive at a net gain or loss from that category. Then, the net gain or loss from each category is combined.
When you carry a capital loss over to the following year, it retains its character as long-term or short-term and must be first combined with the other entries in its category.
Refer to Reporting Capital Gains and Losses in Publication 550 (PDF), Investment Income and Expenses.
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If a stock was sold short prior to the end of the year but was purchased in the next year to cover the short sale, when should it be included on Schedule D?
Generally, gain or loss is realized on a short sale when you deliver the stock that "covers" the short sale, not at the time you sell short. Gain (but not loss) short sale will be recognized earlier under constructive sale rules if the taxpayer subsequently acquire the same or substantially identical property to the property sold short.
Refer to Constructive Sales of Appreciated Financial Positions in either the Instructions for Form 1040, Schedule D or Chapter 4 of Publication 550 (PDF), Investment Income and Expenses for more details and exceptions.
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Since the date acquired is after the date sold, how should I report a short sale on Schedule D?
This can be confusing with a short sale since it is really a two-step process. The date sold is the date that the transaction closes, which is the date you deliver to the lender the stock or (other assets) that cover the short sale. The date acquired is the date you purchased the stock (or other assets) delivered to the lender.
Normally, the short sale of a capital asset is considered to result in short-term gain or loss since the stocks (or other assets) that are delivered to "cover" the short sale are purchased the same time as the delivery. However, if stock held by the taxpayer for greater than one year is used top cover the short sale, then the gain or loss is long-term.
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I held stock substantially identical to the stock I sold short, but I covered the short sale with shares that I purchased later. How does that affect the way I report the short sale?
If you also held substantially identical stock at the time of the short sale, but you acquired new stock to close the transaction, only gain or loss would still be recognized when you close the short sale. However, the loss would be long-term if you held the substantially identical property more than one year at the time of the short sale, regardless of what stock was delivered to close the transaction.
For more information on constructive sales, refer to Constructive Sale treatment for Certain Appreciated Positions in Chapter 4 of Publication 550 (PDF), Investment Income and Expenses.
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Should I advise the IRS why amounts reported on Form 1099-B do not agree with my Schedule D for proceeds from short sales of stock not closed by the end of year that I did not include?
If you are able to defer the reporting of gain or loss until the year the short sale closes, the following will allow you to reconcile your Forms 1099-B to your Schedule D and still not recognize the gain or loss from the short sale:
- Your total of lines 3 and 10, column (d), on your Schedule D should equal your total gross proceeds reported to you on all Forms 1099-B.
- In columns (b) and (c) write "SHORT SALE," and
- in column (f) write "See attached statement."
- In your statement, explain the details of your short sale and that it has not closed as of the end of the year. Include your name as it appears on the return and your social security number.
For more on these rules and exceptions that may apply, refer to Chapter 4 of Publication 550 (PDF), Investment Income and Expenses.
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How do I determine my gain or loss on the proceeds reported on Form 1099-B from a short sale entered into last year if I have not yet bought the stock to deliver back to my broker?
In general, you cannot determine your gain or loss until you purchase the stock that you are going to deliver to close the short sale. You still need to report the gross proceeds on Schedule D so that the total of lines 3 and 10, column (d), reconciles with all of your Forms 1099-B.
Also, in columns b and c write "short sale." In column f, write "see attached statement." In the statement, explain the details of the short sale and that it is not closed. Include your name as it appears on your return and your social security number.
For more information on rules and exceptions that may apply, refer to Chapter 4 of Publication 550 (PDF), Investment Income and Expenses.
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How will the IRS know my stock split?
The IRS is not notified of a stock split.
It is your responsibility to accurately report your income on your return in the year you sell shares of stock and to fully disclose details of the sale on Schedule D. Part of that disclosure is to state the per share basis of the stock sold, which should take into account a stock split.
The broker of the sale reports the proceeds of the sale to the IRS on Form 1099-B The 1099-B also shows the recipient's identity, the payer's identity, and the CUSIP Number that identifies the securities sold.
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Does the holding period for new shares I received as a result of a stock split start on the purchase date of the original stock or on the date of the stock split?
The holding period of the stock you received as a result of the stock split begins on the same day as the holding period of the original stock.
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I purchased stock through an employee stock purchase plan at my work which split three months later. Three months after that, I sold the stock at a gain. How does the split affect how I report the stock sale on my tax return?
With either of the two types of statutory employee stock option plans, there is no income as a result of the granting of the option or the exercising of the option (purchasing stock). These two types of plans are the employee stock purchase plan and the incentive stock option plan. However, if you don't hold the stock long enough to meet the holding period requirements, when the stock is sold you may have to report compensation income (wages). The split will affect the computation of capital gain and compensation income, if any.
For the stock purchased under an employee stock purchase plan to receive favorable tax treatment, it must be held for at least two years after the option is granted and at least one year after the option is exercised. If the holding periods are not met, the lesser of the fair market value of the stock on the grant date minus the option price or the fair market value on the sale date minus the amount you paid for the stock is compensation income (wages). To the extent that the gain is being taxed as wages on your return, it becomes part of your adjusted basis in the stock sold. When determining basis, the amount you paid for the stock is divided equally among the shares received in the split.
For information on incentive stock option plans and nonstatutory stock options, or more information on employee stock purchase plans, refer to Publication 525 (PDF), Taxable and Nontaxable Income
References:
How do I calculate the sale of a stock that had a reverse split?
Reverse splits are where your number of shares in a company's stock decreases. Your total basis remains the same; it is your per share basis that increases. You must divide your basis in the old shares by the number of new shares. For example, you own 4 shares of stock. Two of these shares have a basis of $15 each the other two have a basis of $20 each. There is now a one for two reverse split. Now you have two shares. One has a basis of $30 the other has a basis of $40. If your receive cash because of the sale of a fractional share you have a capital gain or loss that is reported on Form 1040, Schedule D (PDF) , Capital Gains and Losses. Please see Fractional Shares in Publication 550 (PDF), Investment Income and Expenses, for further information on the sale of a fractional share.
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Do I need to pay taxes on that portion of stock I gained as a result of a split?
No, you generally do not need to pay tax on the additional shares of stock you received due to the stock split. You will need to adjust your per share cost of the stock. You overall cost basis has not changed, but your per share cost has changed.
You will have to pay taxes if you have gain when you sell the stock. Gain is the amount of the proceeds from the sale, minus sales commissions, that exceeds the adjusted basis of the stock sold.
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I buy and sell stocks as a day trader using an online brokerage firm. Can I treat this as a business and report my gains and losses on Schedule C?
A business is generally an activity carried on for a livelihood or in good faith to make a profit. Rather than being defined in the tax code, exactly what activities are considered business activities has long been the subject of court cases. The facts and circumstances of each case determine whether or not an activity is a trade or business. Basically, if your day trading activity goal is to profit from short-term swings in the market rather than from long-term capital appreciation of investments, and is expected to be your primary income for meeting your personal living expenses, i.e. you do not have another regular job, your trading activity might be a business.
If your trading activity is a business, your trading expenses would be reported on Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship) instead of Form 1040, Schedule A (PDF), Itemized Deductions. Your gains or losses, however, would be reported on Form 1040, Schedule D (PDF), Capital Gains and Losses, unless you file an election to change your method of accounting.
If your trading activity is a business and you elect to change to the mark-to-market method of accounting, you would report both your gains or losses on Part II of Form 4797 (PDF), Sales of Business Property.
A change in your method of accounting requires the consent of the Commissioner and can not be revoked without the consent of the Commissioner. Though there is no publication specific to day traders, the details for traders information for securities and commodities is covered in Internal Revenue Code Section 475(f) and Revenue Procedure 99-17 and Rev. Proc. 99-49.
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Is there any publication that explains the proper way to file a Schedule C as a day trader?
Publication 550 (PDF), Investment Income and Expenses, which is specific to traders, includes a section titled Special Rules for Traders in Securities.
Internal Revenue Code section 475(f) and Revenue Procedure 99-17 apply only to traders who elect to use mark-to-market method of Accounting.
References:
- Publication 550 (PDF), Investment Income and Expenses
- Publication 535 (PDF), Business Expenses
- Form 3115 (PDF), Application for Change in Accounting Method
- Internal Revenue Code section 475(f)
- Revenue Procedure 99-17
I am a stock day trader. I understand I have the option of electing the mark-to-market method of accounting which would preclude the application of the wash sale rule. What forms and publications do I need?
If your trading activity is a business, your trading expenses would be reported on Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship) instead of Form 1040, Schedule A (PDF), Itemized Deductions. Your gains or losses, however, would be reported on Form 1040, Schedule D (PDF), Capital Gains and Losses, unless you file an election to change your method of accounting to the mark-to-market method of accounting.
See Publication 550 (PDF), Investment Income and Expenses (p. 63) for guidance on how to make the mark-to-market election. You need Form 3115 (PDF), Application for Change in Accounting Method. The mark-to-market method of accounting cannot be revoked without the consent of the Secretary.
If you qualify and elect to change to the mark-to-market method of accounting, you would report your gains or losses on Part II of Form 4797 (PDF), Sales of Business Property.
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I have expenses associated with my day trading business, but I am unsure about how to report my gains and losses. How do I file as a day trader and how do I use the mark-to-market accounting method?
Special rules apply if you are a trader in securities in the business of buying and selling securities for your own account. To be engaged in business as a trader in securities, you must meet all the following conditions.
- You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation
- Your activity must be substantial.
- You must carry on the activity with continuity and regularity.
The following facts and circumstances should be considered in determining if your activity is a securities trading business.
- Typical holding periods for securities bought and sold
- The frequency and dollar amount of your trades during the year.
- The extent to which you pursue the activity to produce income for a livelihood.
- The amount of time you devote to the activity.
If your trading activity is a business, your trading expenses would be reported on Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship) instead of Form 1040, Schedule A (PDF), Itemized Deductions. Your gains or losses, however, would be reported on Form 1040, Schedule D (PDF), Capital Gains and Losses, unless you file an election to change your method of accounting.
If you qualify for and elect to change to the mark-to-market method of accounting, you would report both your gains or losses on Part II of Form 4797 (PDF), Sales of Business Property.
The mark-to-market method of accounting cannot be revoked without the consent of the Secretary. Though there is no publication specific to day traders, the details for traders in securities and commodities are covered in Internal Revenue Code section 475(f) and Revenue Procedure 99-17.
If you elect to use the mark-to-market method of accounting, a security that you hold at the end of the tax year will generally be treated as sold at its fair market value on the last business day of the tax year. Any gain or loss must be recognized. That gain or loss is taken into account as an adjustment in figuring your gain and loss when you later dispose of the security. See Publication 550 (PDF), Investment Income and Expenses, for general information on mark-to-market accounting rules.
References:
- Publication 535 (PDF), Business Expenses
- Publication 550 (PDF), Investment Income and Expenses
- Form 3115 (PDF), Application for Change in Accounting Method
- Form 4797 (PDF), Sales of Business Property
- Internal Revenue Code Section 475(f)
- Revenue Procedure 99-17
I am a day trader. How do I go about paying tax on the gain as a business and not on Schedule D?
Special rules apply if you are a trader in securities in the business of buying and selling securities for your own account. To be engaged in business as a trader in securities, you must meet all the following conditions.
- You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation.
- Your activity must be substantial.
- You must carry on the activity with continuity and regularity.
The following facts and circumstances should be considered in determining if your activity is a securities trading business.
- Typical holding periods for securities bought and sold.
- The frequency and dollar amount of your trades during the year.
- The extent to which you to produce income for a livelihood.
- The amount of time you devote to the activity.
If your trading activity is a business, your trading expenses would be reported on Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship) instead of Form 1040, Schedule A (PDF), Itemized Deductions. Your gains or losses, however, would be reported on Form 1040, Schedule D (PDF), Capital Gains and Losses, unless you file an election to change your method of accounting.
If your trading activity is a business and you elect to change to the mark-to-market method of accounting, you would report both your gains or losses on Part II of Form 4797 (PDF), Sales of Business Property.
The mark-to-market method of accounting cannot be revoked without the consent of the Secretary. Though there is no publication specific to day traders, information for traders in securities and commodities is in Internal Revenue Code Section 475(f) and Revenue Procedure 99-17, Revenue Procedure. 99-49, and Publication 550 (PDF), Investment Income and Expenses.
For details about not-for-profit activities, refer to Chapter 1 in Publication 535 (PDF), Business Expenses. That chapter explains how to determine whether your activity is carried on to make a profit and how to figure the amount of loss you can deduct.
Regardless of whether your day trading activities are reported on Schedule D or on Form 4797, you may need to pay tax on your gains by following the requirements for making estimated tax payments on Form 1040ES (PDF), Estimated Tax for Individuals.
References:
- Publication 535 (PDF), Business Expenses
- Publication 550 (PDF), Investment Income and Expenses
- Form 3115 (PDF), Application for Change in Accounting Method
- Form 4797 (PDF), Sales of Business Property
- Form 1040ES (PDF), Estimated Tax for Individuals
- Internal Revenue Code Section 475(f)
- Revenue Procedure 99-17
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