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Working around the $3,000 deduction cap on trading losses

On Behalf of | Dec 3, 2015 | IRS Issues

Many Georgia residents actively trade stocks and other securities in order to increase the value of their personal investment portfolios. In some cases, people’s efforts are hampered by the $3,000 deduction cap for capital losses that the IRS places on such activities.

This cap on capital loss deductions applies to both individuals and couples. If an investor loses more in a year, the remainder loss will mean additional money that is subject to taxation rather than being able to be reinvested through additional trading. The IRS does allow portions of loss to be carried over to the next calendar year, while allowing an additional $3,000 to be deducted in that successive year. However, this is not an ideal way to have access to money that could otherwise be used for trading purposes.

One possibility investors can explore is determining whether they can instead be considered as a business for trading purposes. If they meet the guidelines as outlined in IRS Publication 550, they can then transfer their investment assets into an LLC for trading purposes. This type of mark-to-market transfer demands that the person then follow the accounting rules promulgated by the IRS for trading companies. Not everyone is eligible for this type of conversion. If it is possible, the business will enjoy an unlimited deduction cap on trading losses.

Individual traders who are active may want to meet with a tax law attorney to determine whether they are eligible to declare their activities as those of a business and whether it is advisable to make such an election. People may want to get advice before forging ahead and transferring their investment assets. If such a move is completed incorrectly, traders may find themselves being subjected to audits with back taxes owed. An attorney may be able to review the law and help a client determine whether such a move is appropriate.