Tax Update Blog: Permalink

« Previous · Tax Update Blog Home · Next »

TRADING PLACES, COUPLE STYLE

August 29, 2007

Melissa Quinn opened an E-trade account in 1999. Like many folks who got caught up in the day-trading frenzy, her account lost money.

Ms. Quinn was married to Lee Arberg. Mr. Quinn elected on his 1998 return to be treated as a "trader" marking his positions to market under Code Sec. 475(f) (a tactic we discussed here). This permitted him to treat his securities losses as ordinary, so that losses weren't subject to the usual $3,000 capital loss limit in 1998 and afterwards.

Unfortunately, it also appears he traded on his wife's account. Their 2000 return claimed a $380,595 mark-to-market loss on her account. The Tax Court ruled that the trades in Ms. Quinn's account couldn't be attributed to her husband, and therefore weren't covered by Mr. Arberg's mark-to-market election. This meant her losses were limited to $3,000, rather than $380,595.

The case provides a very nice summary of the different rules that can cover individual stock trades that is worth reproducing here (citations omitted, emphasis added):

For Federal tax purposes, transactions in securities are conducted in one of three capacities; i.e., as a dealer, a trader, or an investor, and the tax treatment of a given transaction turns upon which of these characterizations applies. Dealers are those who are engaged in the business of buying and selling securities and whose business involves sales to customers. As a result, a dealer's sales of securities are the equivalent of sales of inventory and produce ordinary gains and losses.Attendant business expenses are deductible under section 162(a) and interest is not subject to the restrictions under section 163(d) on the deduction of "investment interest".

Traders, like dealers, are engaged in the trade or business of selling securities, but they do so for their own account. Hence, their securities are not excluded from the definition of a capital asset due to the absence of customers, and sales thereof produce capital gains and losses under generally applicable principles. Because of the trade or business context, however, expenses are deductible under section 162(a) and the interest limitations of section 163(d) do not apply.

Investors likewise buy and sell for their own account, but they are not considered to be in the trade or business of selling securities. Expenses are deductible only under section 212 as itemized deductions, and deduction of interest is restricted by section 163(d). Their transactions, too, are capital in nature.

Nonetheless, a distinction, relevant here, exists between a trader and an investor with respect to capital treatment. Only a trader, and not an investor, is entitled to make a mark-to-market election pursuant to section 475(f), with the consequence that gains and losses are treated as ordinary in character under section 475(d)(3)(A)(i) and (f)(1)(D).

The Moral? If you want ordinary loss treatment, you need to make a timely Sec. 475(f) election, and you need to make the trades in your own account, not your spouse's.

Cite:Arberg and Quinn, T.C. Memo 2007-244

      Bookmark: del.icio.us • Digg • reddit