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When You Can Treat Portfolio Management as a Tax-Deductible Business

Published on: Sep 04 2022

After leaving the career behind, your work isn’t done.

You’re now in the business of ensuring there’s steady cash flow to pay your expenses.

Or, as I put it, you need to generate your Retirement Paycheck.

That leads to a question many people ask:

Can I report managing my retirement portfolio as a business on my income tax return?

Retirees often receive most of their income from their investments. Interest, dividends and capital gains pay the bulk of their expenses.

Some retirees devote enough time and attention to their portfolios that they believe investing has become their job or business.

They ask, for tax purposes, can a retiree be in the business of investing?

The question is asked more frequently since the 2017 tax law eliminated the miscellaneous itemized deduction.

That’s where most people deducted investment expenses and other costs related to their finances, such as tax return preparation.

The deduction is scheduled to return after 2025.

There are tax benefits when investing is your trade or business, which the IRS calls being a trader.

All your investment-related expenses are deducted directly from investment income on Schedule C.

You might be able to deduct a home office expense. Unlike most Schedule C income, the net income from trading isn’t subject to self-employment tax. But a trader can’t deduct Keogh retirement plan contributions.

A trader also has the advantage of electing to mark-to-market all investment positions at the end of each year.

This means you report gains and losses as though you sold each position on the last day of the year, though you didn’t.

So, if you have a net loss on paper at the end of the year, you have a net loss for tax purposes, though you haven’t sold your positions and today’s paper losses might turn into gains next year.

Another benefit of this election is that you can deduct net losses against other income without the $3,000 annual limit other taxpayers face.

A disadvantage of being a trader is you don’t receive the preferential long-term capital gains rate. All net gains and losses are ordinary income or losses.

The IRS and courts tightly limit who qualifies as a trader instead of an investor. Whether you’re an investor or trader depends on your time perspective, your goals, the type of income you earn and the number of transactions you make.

To be a trader, your investment activity must be substantial and must be carried on with regularity and continuity.

You also must seek to profit primarily from daily (or less frequent) market movements and not primarily from interest, dividends, or capital gains.

The IRS will examine the amount of time you devote to investing and whether you are pursuing the activity for a livelihood.

But the key factors are the frequency and dollar amount of your trades during the year and the typical holding period for a security.

You must pass all the tests to be considered a trader.

There have been court cases in which taxpayers engaged in more than 200 trades per year but weren’t considered traders either because their trading wasn’t regular or continuous or because they weren’t trying to profit from daily market movements.

In one case, the taxpayer made 204 trades one year, 303 the next and 1,543 the third year.

The Tax Court said trading for the first year wasn’t substantial, but it was for the next two years.

The taxpayer’s strategy was to buy stocks and then sell call options on them.

The goal was to earn premiums as the options expired without the buyers exercising the right to buy the stock from the taxpayer. The taxpayer generally held options for one to five months and did not trade them daily.

The taxpayer executed trades on 77 days the first year and 99 and 112 days in the following two years.

The court ruled the trading wasn’t frequent, continuous, or regular. Adding all the factors together, the court said the taxpayer wasn’t a trader. (Endicott v. Commissioner., T.C. Memo 2013-199) Notice that it doesn’t matter whether or not you rely on investment income as your main or sole source of income. Instead, the extent and nature of your investment activities are the focus.

There’s no precise formula for being considered a trader for tax purposes, but there are some general rules that can be developed from the cases.

To be a trader, you probably need to execute trades on at least 300 days per year and should execute more than one trade on many days.

You also need to trade for short-term profits, so your strategy and goals matter.

Your average holding period should be measured in hours, days or weeks, not months or years. You’re more likely to be considered a trader if you trade options or futures contracts instead of stocks, bonds, ETFs, or mutual funds.

Also, you can be an investor for some of your securities and a trader for others. If you’re trying to do that, you should use separate brokerage accounts for the two activities.

Some attractive tax benefits are available to those who qualify. But much of your retirement would be spent watching the markets and making trades.

And we’ve all got better things to do with our time!

Editor’s Note: Babe Ruth retired from baseball right in the middle of the Great Depression. For years after he retired, he still regularly shelled out thousands of dollars in medical expenses. Yet, despite big healthcare bills and the country’s dire economic situation, he was able to thrive financially during his retirement in part by taking advantage of a little-known retirement loophole. And the loophole he took advantage of more than 80 years ago still exists today. Click here now to learn more.




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