You’ll make your life as a day trader much easier if you keep track of your expenses as you incur them. You can do this in a notebook, in a spreadsheet, or through personal finance software such as Quicken.
You can deduct investment expenses as miscellaneous itemized deductions on Schedule A of Form 1040 as long as they're considered to be ordinary, necessary, and used to produce or collect income, manage property held for producing income, and directly related to the taxable income produced.Day trading expenses you can deduct:
-
Clerical, legal, and accounting fees: You might use the services of a lawyer to help you get set up, and you'll definitely want to use an accountant who understands investment expenses to help you evaluate your trading strategy and prepare your income tax returns. You can deduct attorney and accounting fees related to your investment income.
-
Office expenses: If you do your day trading from an outside office, you can deduct the rent and related expenses. You can deduct the expenses of a home office, too, as long as you use it regularly and exclusively for business.
Whether or not you deduct your office, you can deduct certain office expenses for equipment and supplies used in your business. You can usually write off roughly $100,000 in computers, desks, chairs, and the like if you use them for trading more than half the time. (The limits change every year.)
-
Investment counsel and advice: The IRS lets you deduct fees paid for counsel and advice about investments that produce taxable income. This includes books, magazines, newspapers, and research services that help you refine your trading strategy. It also includes anything you might pay for investment advisory services.
-
Safe deposit box rent: Have a safe deposit box down at the bank? You can deduct the rent on it if you store any investment-related documents. If you also keep other personal items in the same box, you can only deduct part of the rent.
-
Investment interest: If you borrow money as part of your strategy, and most day traders do, you can deduct the interest paid on those loans as long as it isn't from a home mortgage (that interest is already deductible) and as long as you're not subject to other limitations. In most cases, this is margin interest, and for most day traders, it's relatively small because few day traders borrow money for more than a few hours at a time.
-
State income taxes: If you itemize your deductions, you can deduct state income taxes on interest income that is exempt from federal income tax. But you cannot deduct, as either taxes or investment expenses, state income taxes on other exempt income. In most cases, exempt income is related to government bond transactions, and few day traders will work in those markets.
The 50 states all have different rules about taxation of investment income. Some states with little or no income tax handle investments differently. Because there are so many different issues, state taxation is beyond the scope of this article. Check with your state revenue department and a state-savvy tax expert to see what you need to know where you live.
What You Cannot Deduct
Day traders incur some expenses that can’t be deducted from income taxes. It’s disappointing, but at least if you know what day trading expenses they are upfront, you can plan accordingly.-
Commissions: Every time you make a trade, you have to pay a commission to your broker. It may be small, but you have to pay it. And you can’t deduct that cost. Before you splutter in outrage, read this: You can’t deduct it, but you can add it to cost and subtract it from the proceeds of your trade.
Including the commission in the basis of your trade works like a deduction in terms of the amount of tax you pay, but it’s better for you that it’s not a deduction because it’s not subject to the limitations that affect the deductibility of other expenses.
If your state charges transfer taxes on securities, they are handled the same way as commissions.
-
Stockholder's meetings: Companies hold annual meetings for their shareholders each year, usually at or near the company headquarters. Sometimes they are deathly dull, but others are extravaganzas where the company shows off new products, showcases major accomplishments, and takes questions from anyone in attendance. And a few involve contentious issues that can lead to protests and fighting, which is entertaining to watch if you aren’t directly affected.
For long-term investors, these meetings can offer valuable insights on a company’s prospects. Day traders probably wouldn’t find them very useful. Either way, the IRS won’t let anyone deduct the costs of transportation, hotel stays, meals, and other expenses involved in attending a stockholders’ meeting.
-
Investment seminars: The financial services industry offers all kinds of conventions, cruises, and seminars for day traders. You could spend your days attending training seminars instead of actually trading, if you were so inclined. You’re welcome to go to these, and in many cases, you should. You might learn things that would help you trade more effectively. However, you can’t deduct the costs.
There’s some gray area here. You can’t deduct the costs of attending seminars, but you can deduct the costs of investment counsel and advisory services. Some seminars might qualify as investment advice. This is why you need an experienced tax adviser to help you out.
Did you notice that two of the nondeductible expense categories have the potential to involve travel? The IRS does not want people buying ten shares of Hawaiian Electric Industries stock and then trying to write off a trip to the company’s annual meeting in Honolulu, nor do they consider cruises that happen to include a talk by the author of a book on investing to be bona fide investment counsel. They see these activities as vacations, and vacations are not tax deductible.
