Day trading can be very profitable. But not every trade returns a profit. To the degree that you can write off your losses against your gains, this helps when tax time comes. Unfortunately, not all day traders get to write off all of their losses. We highly suggest to our students at DayTradeSafe that they day trade commodity futures. One of the reasons is that folks who day trade stocks, ETFs, or mutual funds run into a host of tax issues that do not exist in the world of commodity futures trading. By successfully navigating the IRS maze with day trading tax strategies one can avoid problems like the limit of $1,500 per year on day trading losses for married individuals filing solo.

The Commodity Trading 60/40 Split

Day trading in futures provides traders with the benefit of a 60/40 split between long-term capital gains and short term gains, which provides a clear advantage when compared to trading stocks. Under Section 1256 of the IRS code, futures trading profits are always taxed 60% as long-term capital gains and 40% as short-term capital gains. This applies no matter how long or short a time a trade was open for. As an example, with a 20% long-term capital gains rate and a 37% short-term capital gains rate, this come to a maximum total tax rate on commodity futures trading profits of 26.8%. Of course if a person is not in the highest tax bracket, the final tax rate will be substantially lower. No matter the person’s tax bracket trading commodity futures generally works out better for tax purposes that day trading stocks. Section 1256 contracts are also marked to market at the end of each year; traders can report all realized and unrealized gains and losses, and they are exempt from wash-sale rules.

Mark-to-Market Election

Mark-to-market pricing on all contracts is a defining feature of futures markets and makes the final daily settlement price the same for all traders. In contrast to commodity futures, if you day trade stocks your losses are capped at $3,000 for tax purposes and $1,500 for a married person filing separately. Stock traders can get around this but it is a lot of work and requires diligent record keeping in order to make a mark-to-market election to obtain trader tax status

Wash Sale Rules

Another reason for avoiding stocks and focusing on commodity futures in your day trading has to do with wash sale rules. Commodity futures trading is not subject to wash sale rules. A wash sale is when a person sells an investment at a loss and immediately repurchases the same asset. An investor might try this in order to take a capital loss on their taxes but remain invested for the long term. The IRS will not allow such capital losses. When choosing assets to trade, a day trader should be aware that wash sale rules apply to stocks, shares of ETFs, and mutual funds. They do not apply to day trading in futures. While wash sale rules do not apply to trading futures they do apply if you trade options.

Record Keeping

Anyone who goes into day trading as a business may wish to consider if they want to run the business as a sole proprietor or form another type of business entity such as a limited liability corporation taxed as an S corporation An LLC is generally thought of as a way to protect its owners from personal responsibility for its debts or liabilities. However, it can also be useful for day traders. Unlike with a standard corporation, an LLC avoids the “double taxation” that goes with a standard corporation. All income is passed through to the owner to be taxed as ordinary income.. It would be wise to seek professional advice before making this choice. In all cases, competent record keeping is necessary to help comply with tax laws governing day trading no matter what assets you choose to trade or what sort of business entity you choose.