Category: Wash Sale Losses

Wash Sale Losses for Traders: How to Avoid Phantom Income and Costly Tax Traps

September 10, 2026 | By: Robert A. Green, CPA

A practical 2026 guide to the 61-day window, cross-account reporting, IRA traps, year-end planning, and Section 475 MTM

This article is for active securities traders with frequent turnover, multiple brokerage accounts, options activity, or overlap between taxable and retirement accounts.

Executive Summary

Hyperactive trading in the same securities and related options can generate wash-sale loss adjustments totaling tens or hundreds of thousands of dollars—and sometimes more. Those adjustments can create phantom taxable income when losses remain deferred at year-end. In taxable accounts, the losses are usually deferred rather than lost; however, a replacement purchase in an IRA or Roth IRA can cause the tax benefit to be lost permanently.

Form 1099-B reports broker-level wash-sale adjustments generated throughout the year. Still, it does not determine the taxpayer’s complete wash-sale position or distinguish losses already absorbed in closed positions from losses still deferred in open replacement positions at year-end. Broker reporting follows limited rules, principally for covered securities with the same CUSIP in the same account. Taxpayer-level compliance may require a broader review of multiple taxable accounts, IRAs and Roth IRAs, options, short sales, and other substantially identical positions. Spouse or controlled-entity activity may also require analysis under related-party or anti-abuse principles, but it is not automatically attributed to the taxpayer under the text of Section 1091.

Active traders need multi-account, taxpayer-level trade accounting and year-end planning. GreenTraderTax and Green’s annual Trader Tax Guide use consistent practical positions to address areas where the law does not provide a complete mechanical test. Those positions are explained below.

The wash-sale adjustment reported in box 1g of Form 1099-B can be alarming. But the headline number is not the whole story.

Wash sale rules defer a tax loss rather than erase it. The deferred loss is added to the replacement position’s cost basis. It is usually deductible when the replacement position is sold in a transaction that does not trigger another wash sale. The most serious problems arise when losses remain deferred through year-end—or become permanently nondeductible because the replacement purchase is made in an IRA.

What Is a Wash Sale?

A wash sale occurs when a taxpayer sells stock or securities at a loss and, during the 61 days beginning 30 calendar days before the sale date and ending 30 calendar days after the sale date, acquires substantially identical stock or securities or enters into a contract or option to acquire them. IRC §1091(a). The rule is intended to prevent taxpayers from realizing a tax loss while quickly restoring substantially the same investment position.

The rule also applies when the taxpayer acquires substantially identical securities in a taxable exchange. Purchases of replacement shares in an IRA or a Roth IRA can also trigger the rule.

When the rule applies in a taxable account:

The current loss is disallowed.
The disallowed loss is added to the tax basis of the replacement position.
The holding period of the replacement position includes that of the position sold.
If only part of the position is replaced, the wash sale adjustment applies on a share-by-share basis to the matched quantity.

In a taxable-account wash sale, the loss is deferred rather than erased: the disallowed amount is added to the replacement position’s cost basis under IRC §1091(d), and the holding period of the position sold generally tacks onto the replacement position under IRC §1223(3). In practice, tax software applies the rules lot by lot.

A Simple Wash-Sale Example

A trader buys 100 shares for $10,000 and later sells them for $8,000, producing a $2,000 loss. Ten days later, the trader buys 100 substantially identical shares for $8,500.

The $2,000 loss is deferred and added to the replacement shares’ $8,500 purchase price, producing an adjusted tax basis of $10,500. If the trader later sells the replacement shares for $9,500 without another replacement purchase within the wash sale window, the deferred loss is released through the higher basis, resulting in a $1,000 tax loss. The replacement trade produced a $1,000 economic gain, but the higher wash-sale-adjusted basis caused the trader to recognize the correct $1,000 net tax loss across both trades.

Wash sale losses in taxable accounts are therefore usually a timing problem rather than a permanent elimination of the deduction. Repeated trading can keep moving the loss from one replacement position to the next, creating a chain that crosses December 31 and shifts the deduction into the following year. A replacement purchase in an IRA or Roth IRA can produce a different—and potentially permanent—result.

Why Form 1099-B May Not Tell the Full Story

Broker reporting is narrower than the taxpayer’s legal obligation. The IRS Form 1099-B instructions require a broker to report a wash sale when both the loss sale and replacement purchase occur in the same account for covered securities with the same CUSIP. A broker may report more, but it is generally not required to identify a replacement purchase in another account—even in another account at the same brokerage firm.

That difference creates two common problems:

Form 1099-B may omit taxpayer-level wash sales involving another brokerage account, an IRA or Roth IRA, stock and related options, different option contracts, or other substantially identical positions.
A broker’s aggregate wash-sale adjustments for the year may be large even though most of those losses were absorbed into replacement positions that were sold before year-end.

For example, a broker’s Form 1099-B might report aggregate box 1g wash-sale adjustments of $500,000 for the year. That does not automatically mean $500,000 is deferred into next year. If the trader closed the replacement positions and avoided another acquisition during the applicable wash-sale window, little or none of that amount may remain deferred at year-end. Conversely, a smaller cross-account wash sale omitted from Form 1099-B may still require a taxpayer-level adjustment.

Even if a trader sells securities in December, a January purchase can still trigger a wash sale. Avoid acquiring substantially identical property within 30 days after the loss sale; the trader may reenter on day 31.

Consider using TradeLog for taxpayer-level wash-sale calculations. It imports transactions from multiple brokerage accounts, recalculates wash sales across those accounts, and helps reconcile the results with Forms 1099-B. Importing Forms 1099-B into tax software without this broader reconciliation is a much narrower approach and can leave material wash-sale adjustments unreported.

The IRA Wash-Sale Trap Can Make the Loss Permanent

The harshest wash-sale result occurs when an individual sells stock or securities at a loss in a taxable account and, during the 61-day window, an IRA or Roth IRA acquires substantially identical stock or securities. Under Revenue Ruling 2008-5, the taxable-account loss is disallowed, and the individual’s basis in the IRA or Roth IRA is not increased under Section 1091(d). Unlike an ordinary taxable-account wash sale, the tax benefit can therefore be lost permanently.

An IRA does not report wash sales on trades occurring solely inside the retirement account because its gains and losses are not currently taxable. The danger is the interaction between the taxable loss sale and the IRA or Roth IRA replacement purchase. Revenue Ruling 2008-5 addresses IRAs and Roth IRAs; it does not decide the treatment of employer-sponsored plans such as 401(k) or Solo 401(k) plans. The ruling also does not mention other types of IRAs such as rollover IRAs and SEP IRAs.

A practical safeguard is to maintain a do-not-trade list separating securities traded in taxable accounts from positions held in IRAs and Roth IRAs. A trader might trade individual technology stocks in taxable accounts and hold diversified funds in an IRA, provided the positions are not substantially identical.

Section 475 can provide another solution for a trader who qualifies for trader tax status (TTS). For securities properly included in a valid Section 475(f) trading business, Section 1091 does not apply to losses recognized under the mark-to-market rules. The election does not cover properly identified investment securities, and traders should not assume it resolves every transaction involving an IRA or another related account. A separate trading entity with a timely Section 475 election can also help segregate business trading from investment and retirement holdings.

Stocks, Options, ETFs, and Substantially Identical Positions

Section 1091 applies when a taxpayer acquires substantially identical stock or securities, or enters into a contract or option to acquire them, during the wash-sale window. The Code does not provide a complete mechanical test for deciding when different funds or option contracts are substantially identical.

The technical standard. Different ETFs or mutual funds are not automatically outside Section 1091 merely because they have different tickers, CUSIPs, or sponsors. Two unleveraged ETFs tracking the same S&P 500 index can present a substantially identical risk. The legal conclusion depends on the relevant facts and circumstances, including portfolio composition, index methodology, leverage or inverse exposure, investment objective, issuer rights, and other material economic characteristics.

Consider a conservative approach by treating ETFs tracking the same stock index — such as State Street SPDR S&P 500 ETF Trust (SPY) and Vanguard S&P 500 ETF (VOO) — as substantially identical for purposes of wash-sale loss treatment. On the other hand, SPY and VOO have different legal structures, which can support a formal position that they are not substantially identical.

Options on the same underlying security raise a similar interpretive issue when their strikes, expirations, exercise terms, or contract types differ. An exact replacement of the same option contract is the clearest case. Stock-to-option, option-to-stock, and different-option replacements may require analysis of the rights, risks, and economic exposure created by the positions. Cash settlement alone does not remove a contract or option from Section 1091. Section 1091(a), (f). The conservative posture is to treat all option contracts on the same underlying stock as subject to wash sale rules.

The practical positions used for trade accounting. Active traders and preparers need consistent, administrable conventions. GreenTraderTax and Green’s annual Trader Tax Guide apply the following practical positions during the year, unless particular facts require separate treatment, paired with a more conservative safeguard specifically at year-end:

• Different index funds: For ongoing trade accounting during the year, different ETFs or mutual funds are not treated as substantially identical merely because they track the same or a similar stock index — two different S&P 500 ETFs are treated as different securities. This is an aggressive position because the IRS has not provided an explicit safe harbor for same-index funds. As a year-end safeguard, revert to the more conservative technical standard described above for any positions still open across December 31: treat same-index ETFs as substantially identical, and avoid opening a replacement position in the other same-index ETF during the wash-sale window. That protects against a later challenge that the two funds were, in fact, substantially identical.

• Stock and options: Stock and all options on the same underlying security are treated as substantially identical without requiring the strike price, expiration date, or other option terms to match. This is a conservative position and may produce more wash-sale adjustments than a contract-by-contract analysis.

These are longstanding practical accounting positions, not a change in trade-accounting methodology. They resolve uncertain areas consistently; they do not mean that Section 1091 expressly mandates either convention in every factual setting. They also go substantially further than accepting an imported Form 1099-B as complete.

Qualifying Section 1256 contracts follow their own mark-to-market and 60-percent-long-term/40-percent-short-term rules and generally are not handled under the ordinary stock-and-securities wash-sale framework. Securities futures and other derivatives require separate analysis. Section 1091(e) also contains rules for certain short-sale and securities-futures losses. Traders should separately consider the straddle, constructive-sale, and other anti-abuse rules when positions offset one another.

Do Wash-Sale Rules Apply to Cryptocurrency?

Under current federal tax law, directly held ordinary spot digital assets, such as bitcoin, are generally treated as property rather than stock or securities, so Section 1091 ordinarily does not apply. The result may differ depending on whether the asset is an ETF, a trust interest, a tokenized security, a partnership interest, a derivative, or another legal wrapper. Traders should verify current legislation before relying on crypto tax-loss harvesting strategies.

Our legal-wrapper series, scheduled for publication beginning in October 2026, will address bitcoin ETFs and other wrapped financial products in detail.

How Traders Can Break the Wash-Sale Chain at Year-End

Waiting for a February Form 1099-B is too late to prevent a wash-sale loss. Traders should review potential wash-sale deferrals before year-end and coordinate activity across all relevant accounts.

A December loss sale can still produce a wash sale if the trader acquires substantially identical positions during the following 30 days in January.

A practical year-end process includes:

Use TradeLog, the trade-accounting software we recommend for taxpayer-level wash-sale calculations across multiple brokerage accounts. Run its Potential Wash Sales Report in November and again in December so there is time to plan loss sales and avoid replacement trades in January.
Identify securities carrying the largest deferred losses and the replacement tax lots holding those losses.
Sell open replacement positions before year-end to potentially release deferred wash-sale losses, and do not reacquire substantially identical property during the applicable restricted period.
Review and, where appropriate, pause purchases in relevant taxable accounts, IRAs, and Roth IRAs during the restricted period. Include automatic purchases and option activity. Review spouse, controlled-entity, and employer-plan activity separately when related-party or anti-abuse concerns may be present.
Reconcile the year-end carryover by ticker and tax lot so the deferred basis is tracked correctly into the next year.

For example, if a trader sells Apple shares at a loss on December 20, 2026, the trader should avoid Apple shares and substantially identical Apple positions through January 19, 2027, and may reenter on January 20, 2027.

A trader does not need to stop all trading. Under the practical position described above, the trader may switch from one tech stock (Apple) to another tech stock (Google) during the restricted period.

Section 475 MTM Can Eliminate Wash-Sale Accounting for Qualified Traders

Trader tax status (TTS) by itself does not eliminate wash-sale accounting. Section 1091(a) contains an exception for a dealer in stock or securities when the loss arises in the ordinary course of the dealer’s business, but ordinary trader status is not dealer status.

Section 475 is available to a taxpayer who qualifies for TTS and makes a valid, timely Section 475(f) mark-to-market election for the securities trading business. For covered business securities, Section 475 marks open positions to market at year-end, generally treats the resulting gains and losses as ordinary, and provides that Section 1091 does not apply to losses recognized under the mark-to-market rules. The $3,000 capital-loss limitation also does not apply to those ordinary business losses. Sections 475(d)(1), 475(d)(3), and 475(f).

Section 475 is not automatic and cannot ordinarily be elected retroactively after losses occur. It does not cover properly identified investment securities. The taxpayer must make a timely election and comply with the accounting-method-change requirements, including the filing of Form 3115 when applicable. Sole proprietors generally elect by the unextended due date of the prior-year individual return; partnerships and S corporations use the unextended due date of the prior-year entity return. A new entity has a separate internal election procedure within two months and 15 days of inception.

For most calendar-year individuals, the deadline to make a 2026 Section 475(f) election passed on the unextended due date for the 2025 individual return, April 15, 2026. A trader considering Section 475 after that deadline generally is evaluating an election for the following tax year, subject to the applicable rules.

For an active securities trader who qualifies for TTS, Section 475 can provide valuable tax-loss insurance and cleaner accounting. The decision should be made before the election deadline.

Coming soon in this wash-sale series: “How TTS Traders Report Section 475 MTM Gains and Losses on Form 4797,” covering the election, accounting-method change, segregation rules, and return preparation.

Reporting Wash Sales on Form 8949

For a detailed walkthrough of Form 8949 reconciliation, adjustment codes B and M, substitute statements, and Form 8453 filing requirements, see Part 2 of this series: ‘Wash-Sale Accounting: Why Broker Form 1099-B Reporting Is Not Taxpayer Compliance.

Coming in October: Our Legal Wrapper Series

Beginning in October 2026, we plan to publish our legal wrapper series explaining why the term “security” can have different meanings under different tax provisions. Section 475 MTM uses a broader definition for TTS traders, while Section 1091 wash sales uses a narrower one. As a result, an underlying instrument might fall outside Section 1091, while an ETF, option, or other wrapper referencing that instrument might itself be treated as stock or a security under Section 475.

Bottom Line

Wash-sale losses are manageable when traders monitor them during the year, but they become expensive when ignored until tax season. The biggest risks are not the gross annual adjustment in box 1g. They are losses deferred after December 31, unreported cross-account wash sales, permanent losses caused by IRA or Roth IRA replacement purchases, and incorrect basis carried into future years.

Active securities traders should use multi-account trade accounting, coordinate taxable and retirement-account activity, and plan early enough to break the year-end chain. The longstanding practical positions used by GreenTraderTax and Green’s annual Trader Tax Guide provide a workable and consistent method for uncertain ETF and option relationships. Traders who qualify for TTS should also evaluate a timely Section 475 election for the next tax year. TTS traders under Section 475 avoid the confusion and complexity of wash sale losses in their trading activity.

Sources and Further Reading

IRC Sections 1091 and 475; Treasury Regulation Sections 1.1091-1, 1.1091-2, and 1.6045-1; Revenue Ruling 2008-5; IRS Instructions for Form 1099-B (2026); IRS Instructions for Form 8949 (2026); and IRS Publication 550 (2026).

This article is for educational purposes and does not constitute tax advice.

Tips for Options Traders on Preparing 2024 Tax Returns

February 14, 2025 | By: Robert A. Green, CPA

As we move into tax season, options traders must be mindful of how their trading activities impact their tax filings. Understanding the nuances of tax treatment for various types of options, trader tax status (TTS), and available elections can significantly affect your tax liability. This guide provides key insights from Robert A. Green, CPA, on effectively preparing your 2024 federal tax returns.

Equity Options, Wash Sales, and Section 475

Equity options are classified as securities, which means they are subject to wash sale loss (WS) rules. Wash sales occur when a trader sells a security at a loss and then repurchases a substantially identical security within 30 days. Importantly, brokerage firms often do not report WS between equities and equity options on Form 1099-B, but the IRS still requires traders to track these transactions manually.

Traders with TTS can elect Section 475 mark-to-market (MTM) accounting, which exempts securities from wash sale rules and the $3,000 capital loss limitation. The Section 475 election for 2024 was due by April 15, 2024, with the next election deadline set for April 15, 2025.

Futures Options and Section 1256 Contracts

Futures options are classified as Section 1256 contracts. These contracts benefit from lower 60/40 capital gains tax rates, simplified tax reporting, and a Section 1256 loss carryback election, making them more tax-efficient than securities-based options.

Tax Treatment of Options

Options trading involves diverse tax treatments depending on the type of option contract:

Options taxed as securities: These include stock options, options on narrow-based indexes, and options on ETFs structured as registered investment companies (RICs).
Options taxed under Section 1256 include options on U.S.-regulated futures contracts, broad-based indexes, and CBOE-listed options on specific commodity and volatility ETFs and ETNs.

Wash Sale Loss Rules for Security Options

For options classified as securities, wash sales apply to all accounts, including taxable and IRA accounts. Since brokers calculate WS on an account-by-account basis, traders should consider using tax software like TradeLog to track these adjustments accurately.

Simple vs. Complex Options Trades

Simple options strategies, such as buying and selling single-leg calls and puts, have relatively straightforward tax treatment. However, complex options trades, such as spreads, iron condors, and butterflies, trigger additional IRS regulations to prevent tax avoidance through offsetting positions.

Trader Tax Status (TTS) and Business Expense Deductions

Traders who qualify for TTS can deduct business expenses on Schedule C of their tax return. Key TTS qualification factors include:

Trade Volume: A minimum of 720 trades annually.
Frequency and Holding Period: Trading activity on 75% of trading days, with an average holding period of 31 days or less.
Time Spent: More than four hours daily engaged in trading-related activities.
Intent and Operations: Operating with the intention of making a living from trading.

Tax Reporting for a Sole Proprietor Trading Business

Different IRS tax forms apply based on the type of trading activity:

Schedule C: Reports business expenses but not trading gains or losses.
Form 8949 and Schedule D: Used for reporting securities sales and calculating capital gains and losses.
Form 4797: Reports trades under Section 475 MTM for TTS traders, allowing ordinary gain or loss treatment.
Form 6781: Summarizes Section 1256 contracts with the 60/40 tax split.

Section 475 MTM Election

TTS traders may elect Section 475 MTM to benefit from ordinary income tax treatment and exemption from wash sale losses. The election must be made by April 15, 2025, for the 2025 tax year. You can elect it on securities only to retain lower 60/40 tax rates on futures.

Qualified Business Income (QBI) Deduction

Under the Tax Cuts and Jobs Act (TCJA), TTS traders may qualify for a 20% deduction on QBI derived from Section 475 trading gains. However, this deduction will be phased out for married filers with taxable incomes above $383,900 and single filers above $191,950 in 2024.

Tax Treatment for Various Financial Products

Different financial instruments have unique tax treatments:

U.S. and International Equities: Subject to capital gains tax.
Futures and Section 1256 Contracts: Benefit from the 60/40 tax split on capital gains.
Options on ETFs and ETNs: Depending on structure, they may be taxed as securities or Section 1256 contracts.
Cryptocurrencies: capital gains and losses on property using the realization method.
Forex: Typically taxed as ordinary income under Section 988 unless an election is made for capital gains treatment, including 60/40 for major pairs.

Navigating Form 1099-B and Trade Accounting

Many traders experience discrepancies between broker-provided Form 1099-B and IRS requirements, particularly with wash sale loss adjustments. Using software like TradeLog can help traders correctly calculate and report their trading activity in compliance with IRS rules.

Final Thoughts

Understanding the complexities of options taxation is essential for traders aiming to minimize tax liability and ensure compliance with IRS regulations. Traders should consult with a tax professional, such as those at GreenTraderTax.com, to optimize their tax situation and make informed decisions for 2024 and beyond.

For more guidance on tax treatment for options trading, get Green’s 2025 Trader Tax Guide.

This blog post is for educational purposes and does not constitute tax advice. Always consult a qualified tax professional for personalized guidance.

Tax Planning For Traders

September 22, 2023 | By: Robert A. Green, CPA | Read it on

Read our related blog post: Tax Planning For S-Corps.

Traders have unique needs and opportunities in tax planning. Get organized well before the year-end so you don’t miss out.

Recent tax acts don’t change trader tax status (TTS), Section 475 MTM accounting, wash-sale losses on securities, or the tax treatment on financial products, including futures (Section 1256 contracts) and cryptocurrencies (intangible property).

It’s helpful to consider IRS inflation adjustments in income and capital gains tax brackets, various income thresholds and caps, retirement plan contribution limits, standard deductions, and more. See the article, IRS Provides Tax Inflation Adjustments for Tax-year 2023. The IRS increase for 2023 is about 7%.

EXCESS BUSINESS LOSSES AND NET OPERATING LOSSES

TTS traders with a Section 475 election might incur ordinary business losses for 2023. Before the Tax Cuts and Jobs Act (TCJA) started in 2018, a TTS/475 trader could carry back a net operating loss (NOL) for two years, generating a tax refund. TCJA introduced an “excess business loss” (EBL) limitation, with the excess being an NOL carryforward. TCJA repealed NOL carrybacks (except for farmers) and limited NOL carryforwards to 80% of the subsequent year’s taxable income. CARES suspended TCJA’s EBL and NOL changes for 2018, 2019, and 2020 and allowed five-year NOL carrybacks (i.e., a 2020 NOL carryback to 2015). TCJA’s EBL and NOL carryforward rules apply for tax years 2021 through 2028.

DEFER INCOME AND ACCELERATE TAX DEDUCTIONS

Consider deferring income and accelerating tax deductions if you don’t expect your taxable income to decline in 2024.

Traders eligible for TTS in 2023 should consider accelerating trading business expenses, such as purchasing business equipment with first-year expensing using Section 179 or bonus depreciation.

Consider delaying sales of investments to defer capital gains. Defer bonuses at work.

ACCELERATE INCOME AND DEFER CERTAIN DEDUCTIONS

A TTS trader with substantial Section 475 ordinary losses should consider accelerating income to soak up the EBL. Try to advance enough income to use the standard deduction and take advantage of lower tax brackets. Stay below the threshold for unlocking various AGI-dependent deductions and credits. A higher income can lead to an Income-Related Monthly Adjustment Amount (IRMAA) adjustment, raising Medicare premiums.

ROTH IRA CONVERSION

Consider changing a traditional IRA or 401(k) into a Roth IRA. Distributions from a standard retirement plan are taxed as ordinary income (not capital gains), whereas with a Roth IRA, distributions are tax-free.

On the conversion date, the market value of the traditional retirement account is income taxed at ordinary rates. Futures growth and capital in the Roth IRA account are tax-free. If your retirement portfolio is depressed, you might enjoy recovery of values inside a Roth IRA.

Generally, there’s a 10% excise tax on early withdrawals from retirement plans before age 59½. With a Roth IRA conversion, you can avoid excise tax by paying conversion taxes outside the Roth plan. TCJA repealed the recharacterization option, so you can no longer reverse the conversion if the plan assets decline. Roth IRA conversions have no income limit, unlike regular Roth IRA contributions.

As an illustration, a taxpayer filing single has a $405,000 TTS/475 ordinary business loss. However, the excess business loss limitation for a single filing status in 2023 is $289,000 ($578,000 for married), so $116,000 is an NOL carryover. The taxpayer should consider a Roth conversion to soak up most of the $289,000 allowed business loss and leave enough income to use the standard deduction and lower tax brackets.

ZERO TAX RATE ON LONG-TERM CAPITAL GAINS IN THE LOWEST TAX BRACKET

If you have a low income, consider realizing long-term capital gains by selling open positions for over 12 months. The 2023 long-term capital gains rates are 0% for taxable income in the 10% and 12% ordinary tax brackets. The 15% capital gains rate applies to the regular middle brackets, and the top % capital gains rate of 20% applies to the top 37% ordinary income bracket. See capital gains tax brackets at https://taxfoundation.org/data/all/federal/2023-tax-brackets/. Remember, if you go $1 over the zero-rate bracket, all the long-term gains are subject to the 15% capital gains rate; it doesn’t work like progressive marginal ordinary tax brackets.

NET INVESTMENT INCOME TAX

Investment fees and expenses are not deductible for calculating net investment income (NII) for the Affordable Care Act (ACA) 3.8% net investment tax (NIT). NIT only applies to individuals with NII and modified adjusted gross income (AGI) exceeding $200,000 single, $250,000 married filing jointly, or $125,000 married filing separately. The IRS does not index these ACA thresholds for inflation. NII includes portfolio income, capital gains, and Section 475 ordinary income and losses.

BUSINESS EXPENSES AND ITEMIZED DEDUCTION VS. STANDARD DEDUCTION

Business expenses: TTS traders are entitled to business expenses and home-office deductions. The home office deduction requires income, except for the mortgage interest and real property tax portion. The SALT cap on state and local taxes does not apply to the home office deduction.

TCJA expanded first-year business property expensing; traders can deduct 100% of these costs in the year of acquisition, providing they place the item into service before year-end. Traders with TTS in 2023 may consider going on a shopping spree before Jan. 1. There is no sense in deferring TTS expenses because you cannot be sure you will qualify for TTS in 2024.

Employee business expenses: Ask your employer if they have an accountable plan for reimbursing employee-business costs. You must “use it or lose it” before the end of the year. TCJA suspended unreimbursed employee business expenses. TTS S-Corps should use an accountable plan to reimburse employee business expenses since the trader/owner is its employee.

Unreimbursed partnership expenses: Partners in LLCs taxed as partnerships can deduct unreimbursed partnership expenses (UPE). That is how they usually deduct home office expenses. UPE is more convenient than an S-Corp accountable plan because the partner can arrange the UPE after year-end. The IRS doesn’t want S-Corps to use UPE.

SALT cap: TCJA capped state and local income, sales, and property taxes (SALT) at $10,000 per year ($5,000 for married filing separately) and did not index it for inflation. About 29 states enacted SALT cap workaround laws. Search “(Your state) SALT cap workaround” to learn the details for your state. Most states follow a blueprint approved by the IRS.

Generally, elect to make a “pass-through entity” (PTE) payment on a partnership or S-Corp tax return filed by your business. It doesn’t work with a sole proprietorship filing a Schedule C. PTE is a business expense deduction shown on the state K-1 like a withholding credit. Most states credit the individual’s state income tax liability with the PTE amount. Essentially, you convert a non-deductible SALT itemized deduction (over the cap) into a business expense deduction from gross income. Act well before year-end; otherwise, you might delay the benefit to next year.

Investment fees and expenses: TCJA suspended all miscellaneous itemized deductions subject to the 2% floor, which includes investment fees and costs. TCJA left an itemized deduction for investment-interest expenses limited to investment income, with the excess as a carryover.

Standard deduction: TCJA roughly doubled the 2018 standard deduction and suspended and curtailed several itemized deductions. The standard deduction for married couples filing jointly for the tax year 2023 rises to $27,700, up $1,800 (about 7%) from $25,900 in 2022. For single and married individuals filing separately, the standard deduction rises to $13,850 for 2023, up $900 from $12,950 in 2022, and for heads of households, the standard deduction will be $20,800 for the tax year 2023, up $1,400 from $19,400 in 2022. (The IRS should publish the 2024 standard deduction amounts later in 2023.)

Many taxpayers use the standard deduction, simplifying their tax compliance work. For convenience, some taxpayers may feel inclined to stop tracking itemized deductions because they figure they will use the standard deduction. Don’t overlook the impact of these deductions on state tax filings, where you might get some tax relief.

ESTIMATED INCOME TAXES

Those who have reached the SALT cap don’t need to prepay 2023 state-estimated income taxes by Dec. 31, 2023 (a strategy before TCJA). Taxpayers should pay federal and state estimated taxes owed by Jan. 15, 2024, and the balance by April 15, 2024.

Many traders skip making quarterly estimated tax payments during the year, figuring they might incur trading losses later in the year. They can catch up with the Q4 estimate due by Jan. 15, 2024, but might still owe an underpayment penalty for Q1 through Q3 quarters. Some rely on the safe harbor exception to cover their prior year’s taxes. (See Traders Should Focus On Q4 Estimated Taxes Due Jan. 18.)

See Interest rates increase for the fourth quarter 2023.

ADJUST WITHHOLDING ON YEAR-END PAYCHECKS

Employees should consider withholding additional taxes on year-end paychecks, which helps avoid underpayment penalties since the IRS treats wage withholding as being made throughout the year. This loophole applies to officers/owners of TTS S-Corps.

AVOID YEAR-END WASH SALE LOSS ADJUSTMENTS

Taxpayers should report wash sale (WS) loss adjustments on securities based on “substantially identical” positions across all accounts, including IRAs. Substantially identical means equity, an option on that equity (equity option), and those options at different exercise dates.

Conversely, brokers assess WS only on identical positions per the one account and report on the 1099-B for that account. Active securities traders should use a trade accounting program (i.e., TradeLog) to identify potential WS loss problems across all their accounts, especially going into year-end.

In taxable accounts, a trader can “break the chain” by selling the position before year-end and not repurchasing a substantially identical position 30 days before or after in any taxable or IRA accounts. Avoid WS between taxable and IRA accounts throughout the year, as that is a permanent WS loss.

Starting a new entity effective Jan. 1, 2024, can break the chain on individual account WS at year-end 2023, provided you don’t purposely avoid WS with the related party entity. The new entity can also elect Section 475 MTM.

WS losses might be preferable to capital loss carryovers at year-end 2023 for TTS traders. A Section 475 election in 2024 converts year-end 2023 WS losses on TTS positions (not investment positions) into ordinary losses in 2024. That’s better than a capital loss carryover into 2024, which might give you pause when making a 2024 Section 475 election. You want a clean slate with no remaining capital losses before electing Section 475 ordinary income and loss. (Learn how to read a broker 1099-B concerning wash sale loss adjustments in Green’s 2023 Trader Tax Guide Chapter 4.)

TRADER TAX STATUS AND SECTION 475

Traders who qualified for TTS in 2023 may accelerate trading expenses into that qualification period as sole proprietors or entities. Those who don’t qualify until 2024 should try to defer trading expenses until then. Traders may also capitalize and amortize (expense) Section 195 startup costs and Section 248 organization costs in the new TTS business, going back six months before commencement. TTS is a prerequisite for electing and using Section 475 MTM.

TTS traders choose Section 475 on securities to be exempt from wash-sale loss rules and the $3,000 capital loss limitation and be eligible for the 20% QBI deduction. To make a 2023 Section 475 election, individual taxpayers had to file an election statement with the IRS by April 18, 2023 (March 15, 2023, for existing S-Corps and partnerships). If they filed that election statement on time, they must complete the election process by submitting a 2023 Form 3115 with their 2023 tax return. Those who missed the 2023 election deadline may want to consider the election for 2024. Capital loss carryovers are a concern — they can be used against capital gains but not Section 475 ordinary income. The 475 election remains in effect each year until it is revoked in the same manner as the election was made.

A Section 475 election made by April 18, 2024, takes effect on Jan. 1, 2024. When converting from the realization (cash) method to the mark-to-market (MTM) method, a Section 481(a) adjustment needs to be made on Jan. 1, 2024. The adjustment reports in 2024 taxable income the unrealized capital gains and losses on open TTS securities positions held on Dec. 31, 2023. The adjustment should not be made for year-end investment positions, and those who don’t qualify for TTS at year-end 2023 won’t have a Section 481(a) adjustment to report for the 2024 tax year.

A “new taxpayer” entity can elect Section 475 within 75 days of inception — a good option for those who missed the individual sole proprietor deadline (April 18, 2023). Forming a new entity on November 1, 2023, or later, is too late for establishing TTS for the 2023 year within the entity; we would like to see all of Q4 for entity TTS eligibility at a minimum. Consider waiting until Jan. 1, 2024, to start a new TTS entity and elect Section 475.

20% DEDUCTION ON QUALIFIED BUSINESS INCOME

In 2018, TCJA introduced a 20% qualified business income deduction (QBI). In a simple scenario, on a QBI of $100,000, the owner might be able to deduct $20,000. That’s a tax deduction without spending any money.

Trading is a “specified service trade or business” (SSTB), which means an income cap applies. If your taxable income is over that cap, there is no QBI deduction. QBI includes Section 475 ordinary income, less TTS expenses, and excludes capital gains, portfolio income, and forex trading income.

Taxpayers can increase the QBI deduction with thoughtful year-end planning. Suppose taxable income falls within the phase-out range for a specified service activity or even above for a non-service business. You might need higher S-Corp wages (including officer compensation) to avoid a W-2 wage limitation on the QBI deduction. Deferring income can also help get under various QBI restrictions and thresholds. (Learn more about QBI in our tax guide, Chapters 2 and 7.)

SUSPENDING TTS AND SECTION 475

Assume a TTS/475 trader stopped trading on June 30, 2023. They must use Section 475 through June 30, 2023, but may only use it for part of the year. TTS and 475 are “suspended” until and unless the trader is eligible again for TTS in a subsequent year. The trader can also revoke the 475 election for 2024 by April 15, 2024. Without 475 going into year-end, the trader should try to avoid wash sale loss adjustments at year-end.

TAX-LOSS HARVESTING

If you have an investment or trading portfolio, you can reduce capital gains taxes via “tax-loss harvesting” before the year’s end. If you realized significant capital gains year-to-date in 2023 and have open positions with substantial unrealized capital losses, consider selling some losing positions to reduce 2023 taxes on capital gains.

Be sure to wait 30 days to repurchase those securities to avoid wash sale loss adjustments, which would postpone the 2023 year-end tax loss to 2024, thereby defeating the concept of tax loss selling.

You don’t have to wait if you buy a similar security, providing it’s not “substantially identical.” For example, an exchange-traded fund (ETF) like SPY is substantially identical to options on SPY (the derivative) but not to other ETFs that track the S&P 500. The symbol SPX is a stock index future, a Section 1256 contract, which is not a security, so that’s okay to use to avoid wash sales.

TAX EFFICIENT SALES

If you want to sell some of your portfolios, consider taking long-term capital gains subject to lower tax rates (0%, 15%, and 20%) vs. short-term capital gains taxed at ordinary rates. That might require using the “specific identification accounting method” vs. first-in-first-out. (See FIFO vs. Specific Identification Accounting Methods.)

STRADDLES AND THE CONSTRUCTIVE SALE RULES

The IRS has rules to prevent the deferral of income and acceleration of losses in offsetting positions that lack sufficient economic risk. These rules include straddles, the constructive sale rule, and shorting against the box. Also, be aware of the “constructive receipt of income” — you cannot receive payment for services, turn your back on that income, and defer it to the next tax year.

Selling the losing legs on a complex options trade with offsetting positions can trigger the straddle loss deferral rules.

CHARITABLE CONTRIBUTIONS

Consider a charitable remainder trust to bunch philanthropic contributions for itemizing deductions.

You can also donate appreciated securities to charity if you don’t mind. You get a charitable deduction at the fair market value and avoid capital gains taxes. (This is a strategy billionaires use, which you can use.)

Consider directing your traditional retirement plan to make “qualified charitable distributions.” That satisfies the RMD rule, and it’s not taxable income. It’s the equivalent of an offsetting charitable deduction, allowing you to take the standard deduction rather than itemize charitable contributions.

In 2020 and 2021, the limit on charitable contributions increased to 100% of AGI. The limit reverts to the 50% limit for 2022 and subsequent years. (See the IRS site for Charitable Contribution Deductions.)

TAX RELIEF: PRESIDENTIALLY DECLARED DISASTER AREAS

There have been several climate disasters in 2023, including hurricanes, wildfires, winter storms and floods. Check the irs.gov site for Tax Relief in Disaster Situations.

How To Avoid Phantom Income From Wash Sale Loss Adjustments

September 22, 2022 | By: Robert A. Green, CPA | Read it on

Day and swing traders inevitably trigger many wash sale loss adjustments (WS) amounting to tens or hundreds of thousands of dollars. Take a loss on a security, repurchase it within 30 days (after or before), and that creates a WS loss.

A WS reduces the cost basis on the position sold and adds the WS loss to the replacement position’s cost basis. That defers the WS loss, creating phantom taxable income and capital gains taxes.

It’s okay to incur WS losses during the year but try to avoid delaying the WS losses to the following year. Deferring a loss from November to December is acceptable; however, postponing a loss from December 2022 to January 2023 is not.

Learn how to “break the WS chain” at year-end. For example, sell your entire position in security A by December 20, 2022, and don’t repurchase security A for 30 days to around January 21, 2023. That doesn’t provide a WS bridge from the tax year 2022 to 2023. Deduct the whole year of WS losses in 2022, with no deferral of WS losses to 2023.

When you get your broker-issued Form 1099-B showing massive WS loss adjustments, don’t panic. What’s critical is the number of WS open at year-end for which you repurchased positions within 30 days in January 2023. For example, suppose the WS loss adjustments column on the 1099-B is $500,000. If you avoided all WS at year-end by refraining from repurchases in January, the Cost Basis column should be $500,000 greater than your actual purchase price.

On the 1099-B, calculate taxable income by Proceeds, minus Cost Basis, plus WS loss adjustments.

There’s a quirky WS rule between taxable and IRA accounts. The WS loss becomes permanent if you take a loss in a taxable account and repurchase the security position within 30 days in an IRA.

The IRS does not allow you to add the WS loss adjustment to the IRA cost basis. Yet, the IRS requires a reduction of the cost basis in the taxable account.

Avoid this problem with a “do not invest list” in the IRAs vs. what you trade and invest in taxable accounts.

This WS rule applies to taxable vs. IRA accounts; an IRA account on its own is not subject to WS losses.

A trader eligible for trader tax status with a Section 475 MTM election is exempt from WS on trades.

Learn more about WS loss rules at https://greentradertax.com/trader-tax-center/tax-treatment/wash-sale-losses/.