Retail Investor's Guide to Day Trading Taxes

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Day trading is the practice of buying and selling securities within the same day. In some cases, you hold a position for just a few hours or minutes (or less). While the goal of day trading may be to grow your assets, you will owe taxes on any gains in taxable accounts, which can reduce the amount you have left for spending.

Before getting into day trading, it’s crucial to understand how taxes affect your returns. With that knowledge, you can estimate your after-tax returns and avoid nasty surprises.

The U.S. Securities and Exchange Commission warns that day trading is extremely risky. You can lose a substantial amount of money quickly while day trading, and long-term investing may be a better approach for reaching financial goals.


How Are Day Trading Profits Taxed?

The IRS treats most investments like stocks and bonds as capital assets. When you sell an investment for more than you originally paid, you have a capital gain, and that gain typically results in a capital gains tax.

To calculate your gains or losses, compare the purchase amount to the sales proceeds. For example, if you buy shares of stock for $50 and sell at $60, you have a capital gain of $10 per share. But if you sell at $30, you have a capital loss of $20 per share.

For most people, long-term capital gains are taxed at 15%, although you pay higher rates in some situations. Ordinary income tax rates, which apply to short-term capital gains, can go as high as 37%.

Short-Term vs. Long-Term Capital Gains

Your holding period may affect how any profits are taxed. If you hold assets for more than one year, you typically qualify for favorable (lower) long-term capital gains tax rates. But if you sell before then, which is common for day traders, you have short-term gains and losses.

Short-term capital gains rates are generally taxed at the same rate as ordinary income. In other words, any profits would effectively add to your annual income and be taxed at the same rates. Tax rates rise as your income increases, so those with high incomes (or substantial gains) may pay taxes at relatively high rates.

How To File Taxes as a Day Trader

If you’re confident about preparing your own returns, report your transactions on Form 8949. The information on that form should match the information from your brokerage provider’s Form 1099-B. Then, summarize any gains and losses on Schedule D.

Taxes can be complicated, and this article is just an introduction to this complex topic. A professional tax preparer can ensure that your trading activity gets reported correctly, and it’s wise to consult with a CPA to avoid problems.

Estimated Taxes

If you have gains from day trading activity, you may need to make estimated tax payments throughout the year to avoid tax penalties and interest charges. It may be wise to set funds aside as soon as you realize gains, so you’re not tempted to spend the money elsewhere.

How To Minimize Day Trading Taxes

If you’re fortunate enough to grow your account while investing, it may be necessary to pay a portion of your earnings to the IRS. But there are several ways to manage your tax liability.

Retirement Accounts

Gains and losses in retirement accounts like IRAs are typically not subject to taxes each year. Instead, you may owe taxes only when you take withdrawals from those accounts. Better yet, with a Roth IRA, you could qualify for tax-free withdrawals. However, day trading with your life savings is risky, so be wary of taking excessive risks just to avoid taxes.

Withdrawals from pre-tax retirement accounts (like a traditional IRA) are generally taxed as ordinary income—similar to short-term capital gains.

However, you don’t necessarily need to take all of that income in a single year. As a result, it may be possible to manage your income so that you pay taxes at an acceptable rate.

Offsetting Gains and Losses

The goal of investing is to grow your assets, so taking losses is not an ideal strategy. But any capital losses you experience can offset capital gains. As a result, if you need to take a loss, it can help lower the amount you owe in taxes.

However, day traders should be aware of the wash sales rule while trying to harvest losses for tax purposes.

A wash sale occurs when you sell a security at a loss and buy it or acquire it otherwise 30 days before or after the loss making trade. The IRS does not allow deducting loss pertaining to wash sales for tax purposes.

Carryover Losses

If you have losses that exceed your gains for the year, you can potentially use those losses to reduce your tax bill. The IRS allows you to deduct up to $3,000 of capital losses each year ($1,500 if married filing jointly), and you can carry forward losses bigger than that for use in future years.

Tips for Day Traders During Tax Season

Know What Reports Are Available

Find out what reports are available from your trading platform, and provide that information to your tax preparer as soon as possible. Brokerage firms often provide Form 1099-B, which details sales during the year and may also include your cost basis. Monthly and quarterly statements might also tell you about realized gains and losses, helping you understand your potential liability throughout the year.

Track Expenses

Fees, commissions, and other costs you pay when buying can increase your cost basis. Trading frequently can add up expenses even in a low commission environment. With a higher cost basis, your taxable gain is smaller (resulting in a smaller tax liability), so it’s critical to keep track of all trading costs.

Complications With Crypto

If you trade cryptocurrency, prepare yourself for the possibility of additional legwork at tax time. Virtual currencies are relatively new trading vehicles, so tax preparers and other service providers may not have robust systems and extensive expertise to help you. Some trading platforms track your purchases and sales, and can provide detailed activity reports—but it’s critical to check so you’re not scrambling to prepare your taxes. If you mine virtual currency or acquire it in other ways (besides purchasing it on a trading platform), determining your cost basis may be complicated.

Frequently Asked Questions (FAQs)

What is pattern day trading?

Pattern day traders are active traders who are subject to risk management requirements. A pattern day trader executes at least four day trades within a five-business-day window. What’s more, those trades amount to at least 6% of your total trades during that period. However, brokerage firms can use a more restrictive definition, making you a pattern day trader with fewer trades. Pattern day traders must maintain a $25,000 minimum account balance and use a margin account for trading.

How do you practice day trading?

Simulation programs and “paper trading” allow you to practice day trading without putting real money at risk. There are several free simulators available online. You can also track hypothetical trades on a spreadsheet or with a pencil and paper.

When do you pay taxes on day trading profits?

You typically owe taxes on profits only after you sell holdings at a gain. But the timing of payments can be complicated, and you may need to pay estimated quarterly taxes for sales you complete throughout the year. If you pay late, you may owe penalty taxes and interest charges, so speak with a tax professional if you’re unsure when taxes are due.