Abstract: Many taxpayers
incur significant investment-related expenses, which might include payment for
financial service subscriptions, clerical support and home
office maintenance. Under current tax law, these expenses aren’t deductible
through 2025 if they’re considered investment expenses to produce income. If
they’re considered trade or business expenses, however, they are deductible.
This article explains the difference between a trader and an investor. A brief
sidebar describes a court case to illuminate that difference.
Can
you deduct the costs of a self-managed portfolio?
Do
you have significant investment-related expenses, including payment for
financial service subscriptions, home office maintenance and clerical support?
Under current tax law — specifically the 2017 Tax Cuts and Jobs Act — these
expenses aren’t deductible through 2025 if they’re considered investment
expenses to produce income. But they are deductible if they’re considered trade
or business expenses.
For
years before 2018, production-of-income expenses were deductible, but they were
included in miscellaneous itemized deductions, which were subject to a
2%-of-adjusted-gross-income floor. (Unless Congress acts to extend them, these
rules are scheduled to return after 2025.) If you do a significant amount of
trading, you should know which category your investment expenses fall into,
because qualifying for trade or business expense treatment is more advantageous
now.
To
be able to deduct your investment-related expenses as business expenses, you
must be engaged in a trade or business. The U.S. Supreme Court held many years
ago that an individual taxpayer isn’t engaged in a trade or business merely
because the individual manages his or her own securities investments —
regardless of the amount or the extent of the work required.
A
trader vs. an investor
However,
if you can show that your investment activities rise to the level of carrying
on a trade or business, you may be considered a trader, who is engaged in a
trade or business, rather than an investor, who isn’t. As a trader, you’re
entitled to deduct your investment-related expenses as business expenses. A
trader is also entitled to deduct home office expenses if the home office is
used exclusively on a regular basis as the trader’s principal place of
business. An investor, on the other hand, isn’t entitled to home office
deductions since the investment activities aren’t a trade or business.
Since
the Supreme Court decision, there has been extensive litigation on the issue of
whether a taxpayer is a trader or investor. The U.S. Tax Court has developed a
two-part test, both parts of which must be satisfied for a taxpayer to be considered
a trader.
Again,
to pass this test, a taxpayer’s investment activities are considered a trade or
business only if both parts one and two are satisfied.
Contact
us if you have questions or would like to figure out whether you’re an investor
or a trader for tax purposes.
Sidebar:
Profit
in the short term
A
taxpayer’s investment activities may be regular, extensive
and continuous. But that itself isn’t sufficient for determining that the
taxpayer is a trader. To be considered a trader — and therefore entitled to
deduct investment-related business expenses — you must show that you buy and
sell securities with reasonable frequency with the goal of making a profit on a
short-term basis.
In
one U.S. Tax Court case, a taxpayer made more than 1,000 trades a year with
trading activities averaging about $16 million annually. Even so, the
individual was deemed to be an investor rather than a trader, because the
holding periods for stocks sold averaged about one year.
© 2022