Lessons from the Pros


Know Your Trader Tax Terminology

The tax code has more words than the Bible or Tolstoy’s War and Peace making it quite a daunting text. However, by beefing up your knowledge with only a couple of rudimentary terms added to your vocabulary, you’ll be prepared to join forces with your tax accountant early and deal with your trading taxes all the more proactively – for less irritation and (ideally) less taxes paid later on.Tweet: Be prepared to join forces with your tax accountant. https://ctt.ec/fw9cx+

Tax terminology every trader should know.

Tax Terminology Defined:

Cost Basis

Cost basis is a term you’ll hear regularly when talking about taxes for trading and investing. It speaks to the amount you originally paid for a security plus commissions, and is a “baseline” figure from which gains or losses are resolved.

Capital Gains

If your position’s value has risen higher or dropped below your cost basis by the time you close the position, it will generate either a capital gain or capital loss.  Gains on stocks, options, futures, real estate and other types of investment property are capital gains.

Short Term

Any position held for less than twelve months is considered to be held short term.  Capital gains are taxed differently, depending on whether they were short term or long term.  Short term capital gains are taxed at your ordinary tax rate (tax bracket).

Long Term

Positions held longer than twelve months are long term.  Long term capital gains get a special tax treatment and are taxed either at 0%, 15% or 20% depending on your ordinary tax bracket.

60/40 Split

Schedule a Free Tax ConsultationGains and losses from trading futures get a special 60/40 split.  This means 60% of the gain is taxed at the long term capital gains rate while the remaining 40% is taxed at the short term or ordinary tax rate.

For example, if you are in the 28% tax bracket and have $10,000 of gains from trading stocks, then you could pay $2,800 of taxes on those gains.  If instead you had traded futures, you would have paid $2,020 in taxes.

Capital Loss Limitation & Carryforward

Capital losses are limited to $3,000 per year ($1,500 if you are married and file separately).  However, capital losses in excess of the limit are carried forward to future years.  They cannot be carried back to previous years, although there is a special exception for losses from trading futures.

For example, if in 2016 you had $10,000 of losses from trading options and in 2017 you had $12,000 of gains, then you can only deduct $3,000 of losses in 2016 with the remaining $7,000 being carried over to 2017 to offset your gains, so only $5,000 of your 2017 capital gains would be taxable.

Ordinary Gains

Ordinary gains arise from trading forex or making a timely Mark-to-Market election for other asset classes.  Just like short term capital gains, ordinary gains are taxed at your ordinary tax rate.  Unlike capital losses, however, ordinary losses are not subject to a $3,000 limit and may be fully deductible in the year they occur.

For example, if in 2016 you had $10,000 of losses from trading forex, then you get to write off $10,000 of losses.  This reduces your income from other sources, such as wages from your employer or retirement income.

Unrealized Gain or Loss

Unrealized gains or losses are how much your account is up or down at the end of the year.  If you bought AAPL at $110 and it was worth $115 at close on December 31, then you have a $5 unrealized gain.


Securities that are Marked-to-Market are taxed on realized (what you sold) and unrealized (still open) gains or losses at the end of the year.  Forex and futures are marked-to-market.  This means you may pay tax on how much your account is up, even though those positions have not been sold yet.

Marked-to-Market securities are also not subject to Wash Sale rules.

Wash Sales

A wash sale transaction is when a trader sells a losing security to claim a capital loss, but then repurchases the same security within 30 days.  Wash sale losses, which used to be a way to recognize a loss and minimize taxes in a current year, are disallowed until the security has “cooled off” for at least 30 days.  Traders who do high frequency trading with a few favorite stocks can accumulate significant disallowed wash sale losses, resulting in higher taxable gains, until the trader discontinues trading those stocks for 30 days or makes a Mark-to-Market election.

Mark-to-Market Election

Traders who meet the IRS guidelines for qualifying as a Trader in Securities may make a Mark-to-Market election to have their stocks and options trades Marked-to-Market.  Continuing on the above example using APPL stock, this means the $5 unrealized gain at the end of the year would be included in taxable income.  This also means no more disallowed wash sale losses.

Furthermore, the Mark-to-Market election recharacterizes stocks and options as ordinary gains or losses.  This means no more $3,000 capital loss limit.  But it also means you cannot net your trading losses against capital loss carryovers.

Mark-to-Market elections can be very beneficial, but require proper tax planning and must be made timely.  Consult your tax advisor or OTA Tax Pros to see if it is right for you.

Trader in Securities

By default, traders are considered investors for tax purposes.  This means trading income is treated as investment income subject to Net Investment Income Tax and Additional Medicare Tax.  Also, you can only deduct certain expenses and margin interest if there is trading or investment income.

However, the IRS does allow traders who meet certain guidelines and qualify as a Trader in Securities to treat trading as a business.  Traders in Securities can deduct home office costs, depreciate computer equipment, amortize lifetime education investments, elect Mark-to-Market treatment and more.

Our Core Tax Strategies class will teach you how to qualify as a Trader in Securities, which entity is right for you and what expenses are tax deductible.

To learn more visit OTA Tax Pros or call 855-682-7767. We offer a free tax consultation.

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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