You'd think tax questions would slow down in the dead of summer. On the contrary, tax-related trader questions are still coming in, fast and furious. This week we address whether trading in an IRA qualifies for trader status. We'll also discuss some nontrader issues, such as how to switch your method of selling shares and how to move a 401(k) overseas.
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Trading in an IRA
If I am using funds in an IRA for all of my trading, can I be considered a trader? -- Janis Foley
On this question, like many trader tax issues, the
Internal Revenue Service
offers no written guidance.
To start, you know that you cannot report gains and losses on your trades while they are in a tax-deferred account. And in most instances, any expenses related to a tax-deferred account are not deductible. So trader status may be a moot point.
"But there is nothing written that prevents the election of trader status by someone who traded only, or predominantly, in retirement accounts," says Ted Tesser, trader tax specialist and author of
The Trader's Tax Survival Guide
But it's a risky strategy. "If you say you are a trader, then you are saying that your retirement plan is a business, and you cannot run a business in your retirement plan," notes Tesser.
Switching Accounting Methods
I have been using a first-in, first-out rule in paying taxes on gains and losses on common stocks. Is it legal to vary this and do first-in, last-out accounting if this results in a better tax strategy? -- Jesse Clanton
The answer depends on whether you're selling stocks or mutual fund shares.
With stocks, you can switch from first-in, first-out (meaning that the first shares you purchased are the first to go) to first-in, last-out at any time. Or better yet, you can switch to "specific lot identification," says Tesser. Identifying lots is better because it enables you to sell your highest-cost stock first.
It's very important that you inform your broker, in writing, if you're identifying specific lots. (See a previous
Tax Forum for more about identifying the lots you want to sell.)
With mutual funds, if you choose one method for a particular fund, you must stick to that method. So if you sell some shares using the first-in, first-out method, you can't switch later to first-in, last-out. You can, however, use different methods for different funds. You also have one additional accounting method with funds: average cost.
Whether you're a stock or a fund investor, if you use more than one accounting method, you do not have to file anything with the IRS. Just make sure you keep your personal records in intact.
Trading Houses Like Mister Softee
On Aug. 10, you wrote, "If you sold your home in 1998, you won't pay tax on the first $500,000 gain ($250,000 if you're single) as long as it was your principal residence and you owned it for two of the last five years." I'm having trouble making sense of this. If, in 1998, I'm selling a home I owned for two of the past five years, I must have owned it when I sold it. So I had to have owned it for two years to not pay tax on the first $500,000 of gain. This I understand. But why "two of the past five years"? Do people buy and sell and then buy again the same house like others trade Microsoft (MSFT) - Get Report? -- Dick Moores
Believe it or not, some people do sell their homes as often as they flip their stock portfolios.
Workers are relocated all the time. The stock market has been rewarding investors, and the real estate market has also been strong in many areas of the country. As a result, owing more than one home is not that unusual anymore. So it's possible people can be selling homes all the time.
But the IRS does not want you to run up gains and not pay taxes on them, says Christina Tomeo, a senior tax manager at
Dorian A. Vergos
, an accounting firm in New York. Requiring people to own -- and live -- in their houses for two of the last five years cuts down on the potential for abuse.
This two-of-the-last-five-years requirement "didn't just come out of the air," notes Tomeo. The old rule used to be three of the last five years. And if you were over 55, then you could exclude only $125,000 of your gain.
In addition, if you sold your home under the old rule and purchased a new, more expensive home, you could defer any gain you made on the sale of the first home. So as long as you kept moving into bigger and better homes, you could keep putting off paying any tax on your gains. The new rules have put a stop to this.
The new rules may be great for folks who have been in their homes for years. But for people who keep buying bigger and better homes and relocating, they're a big bummer.
-- Selling your Home
for more details.
Taking a 401(k) to Greece
I have been a professional in the U.S. for several years and have accumulated a sizable investment in 401(k) and IRA accounts. If I repatriate to my country, Greece, and file a Form W-8 with my 401(k) and IRA trustees and then withdraw assets, how will these be taxed? If I withdraw less than the personal deduction levels, let's say $5,000 per year, do I pay only the 10% penalty? Also, if I retain a brokerage account in the U.S. and incur capital gains during the year, do I have to file a tax return? -- Pete Tsaoussis
The taxability of your withdrawals will depend on two things: your status with your company and the
tax treaty between the U.S. and Greece.
If you are leaving your company as well as the country, you probably should first roll the 401(k) into IRA. It will make life easier since the 401(k) plan is unique to the U.S.
"Then you need to check out the treaty to see if there is any relief from taxation of IRA distributions," says Daniel Orchant, a partner in the international executive services group at
in New York.
These treaties generally include a section that addresses pensions and tax-deferred accounts. Some treaties allow foreigners to withdraw retirement money U.S. tax-free. Others do not.
If, on the other hand, you're staying with your company, you probably can't take a distribution until you retire, says Orchant.
For more international tax questions, read the
Global Tax Forum every other Wednesday.
TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.