To Get your Section 475 Trader Benefits
That’s the story in Richard Kay, Jr., 2011 T.C. Mem. 159, filed 7/6/11. Richard owned and operated a ball bearing business, but he claimed as well to be a day trader. So he took the mark-to-market year-end Section 475(f) election for all years at issue. That means he could take losses based on last-day-of-year prices even if he didn’t dispose of the stock. And traders can take paper losses against ordinary income without limit, unlike investors who are limited to the $3000 capital loss limitations.
But Judge Cohen disposes of Richard’s trader status thus: one who buys and sells securities is either a dealer, a trader, or an investor. No one says Richard is a dealer. Richard says “trader”, IRS says “investor”.
A trader is one who buys and sells for his/her own account as a trade or business; an investor likewise buys and sells for his/her own account, but is not engaged in a trade or business. So the question is the one Tosca asked Scarpia: “Quando?” “How much?”
How much trading activity did Richard actually engage in, while also running the ball bearing business?
Not enough, says Judge Cohen: “In determining whether a taxpayer is a trader, nonexclusive factors to consider are: (1) The taxpayer’s intent, (2) the nature of the income to be derived from the activity, and (3) the frequency, extent, and regularity of the taxpayer’s securities transactions. Purvis v. Commissioner, 530 F.2d 1332, 1334 (9th Cir. 1976), affg. T.C. Memo. 1974-164. For a taxpayer to be a trader, the trading activity must be substantial, which means “‘frequent, regular, and continuous enough to constitute a trade or business’”. Ball v. Commissioner, T.C. Memo. 2000-245 (quoting Hart v. Commissioner, T.C. Memo. 1997-11). A taxpayer’s activities constitute a trade or business where both of the following requirements are met: (1) The taxpayer’s trading is substantial, and (2) 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. King v. Commissioner, supra at 458-459; Mayer v. Commissioner, T.C. Memo. 1994-209.” 2011 T.C. Mem, 159, at pp. 7-8.
Over the three years at issue, Richard made fewer than a thousand trades. While he traded in big numbers, the amount of money involved is not dispositive. Richard actually traded on just 29 percent, 7 percent, and 8 percent, respectively, of the possible trading days in each year at issue. Moreover, his trading wasn’t in-and-out, the kind of quick-flip of a trader looking to make profits on a series of trades. He held most stocks for more than a day, unlike the trader who does not let the sun set on his/her portfolio.
And most of Richard’s income came from, and most of his time was spent on, the ball bearings, not the stock market.
In short, Richard is an investor, not a trader.
Takeaway- As the lottery slogan says, “ya gotta be in it to win it.”