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Deducting the Costs
of A Self-Managed Portfolio

Do you have significant investment-related expenses, including payment for financial service subscriptions, home office maintenance and clerical support? Under the 2017 Tax Cuts and Jobs Act (TCJA), these expenses aren’t deductible if they’re considered investment expenses to produce income. But they are deductible if they’re considered trade or business expenses.

Changing Rules

For years before 2018, production-of-income expenses were deductible as miscellaneous itemized deductions subject to a 2%-of-adjusted-gross-income floor. But the TCJA generally suspended such miscellaneous deductions through 2025.

As a result, only the trade or business expense deduction is currently available for investment-related expenses. If you do a significant amount of trading, you should know which category your investment expenses fall into, because qualifying for trade or business expense treatment is more advantageous now.

A Trader vs. an Investor

To be able to deduct your investment-related expenses as business expenses, you must be engaged in a trade or business. The U.S. Supreme Court held many years ago that individual taxpayers aren’t engaged in a trade or business merely because they manage their own securities investments, regardless of the amount or the extent of the work required.

However, if you can show that your investment activities rise to the level of carrying on a trade or business, you may be considered a trader, who is engaged in a trade or business, rather than an investor, who isn’t. As a trader, you’re entitled to deduct your investment-related expenses as business expenses.

A trader is also entitled to deduct home office expenses if the home office is used exclusively on a regular basis as the trader’s principal place of business. An investor, on the other hand, isn’t entitled to home office deductions because the investment activities aren’t a trade or business.

A Two-Part Test

Since the Supreme Court decision, there has been extensive litigation on the issue of whether a taxpayer is a trader or investor. The U.S. Tax Court has developed a two-part test, both parts of which must be satisfied for a taxpayer to be considered a trader:

1. The taxpayer’s trading is substantial (in other words, sporadic trading isn’t considered a trade or business), and

2. The taxpayer seeks to profit from short-term market swings, rather than from long-term holding of investments. A taxpayer’s investment activities may be regular, extensive and continuous.

But that itself isn’t sufficient for determining that the taxpayer is a trader. To be considered a trader (and therefore entitled to deduct investment-related business expenses) you must show that you buy and sell securities with reasonable frequency with the goal of making a profit on a short-term basis.

In one U.S. Tax Court case, a taxpayer made more than 1,000 trades a year with trading activities averaging about $16 million annually. Even so, the individual was deemed to be an investor rather than a trader, because the holding periods for stocks sold averaged about one year.

Passing the Test

Again, to pass the trader test, both parts one and two must be satisfied. Contact HHCBR, a CPA firm, Altamonte Springs, FL, (407) 260-9101, if you have questions or would like to figure out whether you’re an investor or a trader for tax purposes.

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