I have been trading in my IRA full-time for a month now and wonder if I can call myself a trader for tax purposes. I intend to draw money from my IRA as a main financial support for my family (I'm aware of 10% early withdrawal penalty).
-- Sonny Le
In a moment, I'll pitch in my two cents on full-time trading in your IRA. But I don't want to weigh in before giving you an answer, so let's jump right in with your question first.
Here's a shocker. On this issue, like many other trader tax concerns, the
Internal Revenue Service
offers no written guidance. So we have to go with conventional wisdom.
There are two big perks to electing to file as a trader on your tax return. You have the option of reporting an infinite amount of capital losses, plus you can report an unlimited amount of trading-related expenses. Remember, as a regular ol' investor, your losses are limited to the amount of your capital gains, plus an additional $3,000 a year and you can deduct expenses only in excess of 2% of your adjusted gross income. So qualified traders can get quite an advantage. (See our
Taxes for Traders
column for more details on the benefits of filing as a trader.)
But when you trade in a tax-deferred account, like an IRA, you cannot report any capital gains or losses generated from trading in that account. In addition, trading expenses are not deductible if they are charged to your tax-deferred account.
So in this instance, electing trader status may be pointless.
There's a bigger issue here. By electing trader status, you are telling the IRS that you have a trading business. But as far as the IRS is concerned, saving for your own retirement is not a business. By claiming trader status then, you're risking the tax-deferred status of your retirement account because a trading business should be in a taxable account. Granted, there are no court decisions in this area, but this is the current belief at the IRS.
Why this thinking? If you had a trading business in a taxable account, the IRS would be getting its money as you earned it. That's how it works for most businesses. But with a tax-deferred account, that income is taxed only when it's taken out. So, sure, the IRS will get its share, but not as a direct result of your trading activity.
While you cannot report your IRA's trading gains and losses on your tax return, you may be able to deduct some trading costs.
Expenses charged directly to your IRA account -- commissions, investment advisory fees, broker fees -- are
deductible. But if you ask your broker to bill those expenses directly to you, you can take them as a deduction on
-- Itemized Deductions
Any expenses you incur outside your IRA that help you make trading decisions are deductible on Schedule A, as well. That includes accounting fees, books, tapes, subscriptions and tax advice. Check out this
list of deductions
for more ideas.
On a separate note, let me say that I don't think it's the best idea in the world to trade and live off your retirement account, since it seems like you are under age 59 1/2. If that's true, you will owe a 10% early withdrawal penalty plus ordinary income tax on any money withdrawn, as you stated above. You would not owe the 10% penalty if you were at least 59 1/2.
But I'm going to assume that you'll make enough money trading to justify that extra tax hit. In addition, I'm going to assume that you have an additional account set aside for your retirement so you are not living on the street in your old age.
But we all know what happens when we assume, now don't we?
A Big College Thanks
Special thanks to all of you who joined Joe Hurley, author of
The Best Way to Save for College
, and me for a
chat on Thursday afternoon. We addressed a ton of issues surrounding the state-sponsored college savings plans. If you missed it, be sure to read the transcript
. And check out Joe's Web site at
for more info.
Send your questions and comments to
, and please include your full name. Investor Forum appears Tuesdays, Thursdays and Saturdays.
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