A deduction for depreciation of a computer for business use can be expensed in the first year if qualified, or depreciated over the recovery period. To claim the expense in the first year, the property must be used more than 50% for business use, and meet the other requirements for expensing.

The 2003 Jobs and Growth Tax Relief Reconciliation Act of 2003 raised the aggregate cost that can be expensed for any tax year after 2002 and before 2006 to $100,000. The new law also expanded the definition of Code Section 179 property to include off-the shelf computer software. See Code Section 179 for the expanded definition.

If you make a choice to depreciate the property you can claim a special depreciation allowance for qualified property you acquired in service after September 10, 2001 and before January 1, 2005. The allowance is a depreciation deduction equal to 30% of the property's depreciable basis. The special depreciation is figured before you calculate your regular depreciation. To qualify for the special deduction the property must:

See Publication 946, How to Depreciate Property for additional information on the special deduction.

The 2003 Jobs and Growth Tax Relief Reconciliation Act of 2003 modified the bonus depreciation rule by substituting a 50% special depreciation allowance for the 30%, for property acquired after May 5, 2003 and before January 1, 2005. No binding contract for acquisition can be in effect before May 6, 2003. Property eligible for the 50% additional first-year depreciation is not eligible for the 30% additional first-year depreciation. However, an election can be made to have the 30% additional first-year depreciation deduction apply to the 50% depreciation property instead of the 50% additional firs-year depreciation deduction. It is also possible to elect not to claim the additional first-year depreciation.

References:

• Publication 946, How to Depreciate Property
• Publication 535, Business Expenses

Only property used in a trade or business or in an income production activity can be depreciated. Additionally, the property must be something that wears out or becomes obsolete and it must have a determinable useful life substantially beyond the tax year. The kinds of property that can be depreciated include, but are not limited to, machinery, equipment, buildings, vehicles, and furniture. Depreciation is a complex topic. For more information, refer to Tax Topic 704, Depreciation, or Publication 946, How to Depreciate Property , or Publication 534 (PDF) , Depreciating Property Placed in Service Before 1987.

References:

• Publication 534 (PDF) , Depreciating Property Placed in Service Before 1987
• Publication 946 , How to Depreciate Property
• Tax Topic 704 , Depreciation

You may deduct investment expenses (other than interest expenses) as miscellaneous itemized deductions on Form 1040, Schedule A (PDF), line 22, Itemized Deductions. This would include depreciation on the portion of your computer used for investment purposes, and the portion of your internet access charges used for investment purposes.

A deduction for depreciation of a computer for business use can be expensed in the first year if qualified, or depreciated over the recovery period. To claim the expense in the first year, the property must be used more than 50% for business use, and meet the other requirements for expensing.

The 2003 Jobs and Growth Act raised the aggregate cost that can be expensed for any tax year beginning after 2002 and before 2006 to $100,000. The new law also expanded the definition of Code Section 179 property to include off-the-shelf computer software. See Code Section 179 for the expanded definition. If the business use falls to 50% or less in a later year, these tax benefits may be subject to recapture. See Publication 946 , How to Depreciate Property for additional information on the special deduction.

These deductions must be reduced by 2% of your adjusted gross income. Use Form 4562 (PDF), Depreciation and Amortization, to compute the depreciation for the portion of your computer used for investment purposes.

Note: Unless the computer is used more than 50% for business purpose (as opposed to investment purposes), you cannot claim section 179 expensing of the computer or claim accelerated depreciation for it. For more information, refer to "Listed Property" in Publication 946, How to Depreciate Property.

References:

• Form 1040, Schedule A (PDF), Itemized Deductions
• Form 4562 (PDF), Depreciation and Amortization
• Publication 946, How to Depreciate Property
• Publication 535 , Business Expenses

You can claim a depreciation deduction for a computer that you use in your work as an employee if its use is:

Use Form 4562 (PDF) , Depreciation and Amortization , to compute the depreciation. There have been recent changes to the percentage of depreciation claimed in the first year you place the property in service.

The cost of a computer purchased for business use can be expensed under section 179 in the first year if qualified, or depreciated over the recovery period. To claim the expense in the first year, the property must be used more than 50% for business use, and meet the other requirements for expensing.

The 2003 Jobs and Growth Act raised the aggregate cost that can be expensed for any tax year after 2002 and before 2006 to $100,000. The new law also expanded the definition of Code Section 179 property to include off-the shelf computer software. See Code Section 179 for the expanded definition.

If you make a choice to depreciate the property you can claim a special depreciation allowance for qualified property you acquired after September 10, 2001 and before January 1, 2005. The allowance is figured before you calculate your regular depreciation. See Publication 946 , How to Depreciate Property for additional information on the special deduction.

You cannot take a section 179 deduction for the item or claim accelerated depreciation unless your use of the computer is more than 50% business or job-related use (and you meet the two conditions listed above).

Section 179 deductions and accelerated depreciation methods are explained in Publication 946, How to Depreciate Property.

References:

• Publication 946, How to Depreciate Property
• Code Section 179

The maximum deduction (including any amounts deducted under section 179) that can be claimed for a used passenger automobile or one that is Liberty Zone property that was placed in service in 2003 is $3,060 for the first year, $4,900 for the second year, $2,950 for the third year, and $1,775 for the fourth and following years. For a new passenger automobile acquired on or before May 5, 2003 (and not Liberty Zone property), the first year deduction is limited to $7,660 (or $3,060 if the owner elects not to take the 30 percent additional bonus depreciation allowance. The 2003 Jobs and Growth Tax Relief and Reconciliation Act provided that for qualified vehicles purchased after May 5, 2003, the first-year depreciation deduction is limited to $10,710 (or $3,060 if the owner elects not to take either the 30% or the 50% bonus depreciation allowance). Subsequent year limits are the same as for used vehicles. Some what higher limits apply to owners of trucks and vans. For more information refer to Publication 946, How to Depreciate Property and Publication 463, Travel, Entertainment, Gift, and Car Expenses

References:

• Publication 463, Travel, Entertainment, Gift, and Car Expenses
• Publication 946, How to Depreciate Property

A Sole Proprietor's business use of a car or truck is claimed on line 10 of Form 1040 (PDF), Schedule C, Profit or Loss from Business or, if eligible, line 2 of Form 1040, Schedule C-EZ (PDF), Net Profit from Business. You may use either the actual expense method in calculating your car or truck expense or, if eligible, the 2003 standard mileage rate of 36 cents per mile. Depreciation expense is already included in this standard mileage rate. Depreciation is only calculated as a separate expense when using the actual expense method. Deductible employee business use of a car or truck may be taken on Form 2106 (PDF), Employee Business Expenses , or if, eligible, line 1 of Form 2106-EZ (PDF), Unreimbursed Employee Business Expenses. The car and truck expenses are then taken with other employee business expenses on line 20, Form 1040, Schedule A&B (PDF) Itemized Deductions . For more information, refer to Publication 463, Travel, Entertainment, Gift, and Car Expenses , and Publication 535, Business Expenses .

References:

• Publication 535, Business Expenses
• Publication 463, Travel, Entertainment, Gift, and Car Expenses
• Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship)
• Form 1040, Schedule C-EZ (PDF), Unreimbursed Employee Business Expenses.
• Form 2106 (PDF), Employee Business Expenses
• Form 2106EZ (PDF), Unreimbursed Employee Business Expenses

If you have qualified business use of your home and enough gross income from that business use to that entitle you to a depreciation deduction, you are required to reduce your basis in the home by the amount of depreciation allowed (deducted) or allowable (could have been deducted).

Whether you choose to deduct the depreciation on your current return(s) will not matter. For tax purposes, you will still be treated as if you had taken the allowable deduction, and your basis will have to be reduced. For more information, refer to Publication 946, How to Depreciate Property, Publication 544, Sales and Other Dispositions of Assets, and Publication 587, Business Use of Your Home.

References:

• Publication 946, How to Depreciate Property
• Publication 544, Sales and other Dispositions of Assets
• Publication 587, Business Use of Your Home

You do not have to claim depreciation on your rental property on your tax return. However, when reporting the sale of the rental property you are required to reduce the basis of the property for allowable depreciation regardless of whether the depreciation deduction was taken or not. For more information, refer to Publication 544, Sale or Other Dispositions of Assets, the Instructions for Form 4797, Sale of Business Property, and Publication 527, Residential Rental Property (including vacation homes).

References:

• Publication 544, Sale or Other Dispositions of Assets
• Instructions for Form 4797, Sales of Business Property
• Publication 527, Residential Rental Property (including Vacation Homes)

You can claim a special depreciation allowance for qualified property you acquired after September 10, 2001 and before January 1, 2005. The allowance is a depreciation deduction equal to 30% of the property's depreciable basis. The special depreciation is figured before you calculate your regular depreciation. To qualify for the special deduction the property must:

See Publication 946, How to Depreciate Property for additional information on the special deduction.

The Jobs and Growth Tax Relief Reconciliation Act of 2003 modified the bonus depreciation rule by substituting a 50% special depreciation allowance for the 30%, for property acquired after May 5, 2003 and before January 1, 2005. No binding contract for acquisition can be in effect before May 6, 2003. Property eligible for the 50% additional first-year depreciation is not eligible for the 30% additional first-year depreciation. However, an election can be made to have the 30% additional first-year depreciation deduction apply to 50% depreciation property instead of the 50% additional first year depreciation deduction. It is also possible to elect not to claim the additional first-year depreciation deduction.

References:

• Publication 527, Residential Rental Property
• Publication 946, How to Depreciate Property

Replacement of a roof on a residential rental property is a capital improvement to the structure. The roof is in the same class of property as the property to which it is attached. Since the property is residential rental property, the roof is generally depreciated over a residential rental property recovery period of 27.5 years using the straight line method of depreciation and a mid-month convention. You cannot write off (or take a loss on) any remaining basis in the replaced roof. For more information, refer to Publication 527, Residential Rental Property, and Publication 946, How to Depreciate Property.

References:

• Publication 527, Residential Rental Property
• Publication 946, How to Depreciate Property

Replacement of windows and siding on a residential rental property is a capital improvement to the structure, provided the replacement improves the value of this property or substantiality prolongs its life. The windows and siding, in that event, are in the same class of property as the property to which they are affixed. In this case, the windows and siding are generally depreciated over a recovery period of 27.5 years using the straight line method of depreciation and a mid-month convention. For more information, refer to Publication 527, Residential Rental Property, and Publication 946, How to Depreciate Property.

References:

• Publication 527, Residential Rental Property
• Publication 946, How to Depreciate Property

Replacements of roof, rain gutters, windows, and furnace on a residential rental property are capital improvements to the structure because they materially add to the value of your property or substantially prolong its life. The items would be in the same class of property as the rental property to which to which they are attached. Since the property is residential rental property, the items are generally depreciated over 27.5 years using the straight line method of depreciation and a mid-month convention.

Repairs, such as repainting the house, are currently deductible expenses. A repair keeps your property in good operating condition. It does not materially add to the value of your property or substantially prolong its life. Repainting your property inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows are examples of repairs. If you make repairs as part of an extensive remodeling or restoration of your property, the whole job is an improvement. In that case, you should capitalize and depreciate the repair costs as the same class of property that you have restored or remodeled as discussed above. For more information, refer to Publication 527, Residential Rental Property, and Publication 946, How to Depreciate Property.

References:

• Publication 527, Residential Rental Property
• Publication 946, How to Depreciate Property

Replacement of a furnace in a residential rental property is a capital improvement to the structure. The furnace is in the same class of property as the property in which it is installed. Since the property is residential rental property, the furnace is, generally, depreciated over a recovery period of 27.5 years using the straight line method of depreciation and a mid-month convention. For more information, refer to Publication 527, Residential Rental Property, and Publication 946, How to Depreciate Property.

References:

• Publication 527, Residential Rental Property
• Publication 946, How to Depreciate Property

You cannot claim section 179 expense for property held to produce rental income (since it is use in connection with the furnishing of lodging). These assets are classified as 5-year property and must be depreciated under MACRS (Modified Accelerated Cost Recovery System).

You can claim a special depreciation allowance for qualified property you acquired service after September 10, 2001 and before January 1, 2005. The allowance is a depreciation deduction equal to 30% of the property's depreciable basis. The special depreciation is figured before you calculate your regular depreciation. To qualify for the special deduction the property must:

See Publication 946 , How to Depreciate Property for additional information on the special deduction.

The Jobs and Growth Tax Relief Reconciliation Act of 2003 modified the bonus depreciation rule by substituting a 50% special depreciation allowance for the 30%, for property acquired after May 5, 2003 and before January 1, 2005. No binding contract for acquisition can be in effect before May 6, 2003. Property eligible for the 50% additional first-year depreciation deduction is not eligible for the 30% additional first-year depreciation deduction apply to 50% depreciation property instead of the 50% additional first-year depreciation deduction. It is also possible to elect not to claim the additional first-year depreciation.

References:

• Publication 527, Residential Rental Property
• Publication 946, How to Depreciate Property

If you claim a section 179 deduction for the cost of property in the year you place the property in service, and in a subsequent year, you do not use it more than 50 percent for business, you may have to recapture part of the section 179 deduction. This can occur in any year during the recovery period for the property even though the items have not been sold. Refer to Publication 946, How to Depreciate Property, on how to calculate the recapture amount. The recapture amount is computed on part IV of Form 4797 (PDF), Sale of Business Property, and is included as other income on line 6 of Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship).

References:

• Publication 946, How to Depreciate Property
• Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship)
• Form 4797 (PDF), Sale of Business Property

If someone owes you money that you cannot collect, you have a bad debt. Bad debts are deductible only if the amount owed has been previously included in your income. For a discussion of what constitutes a valid debt, see Publication 535, Business Expenses and Publication 550, Investment Income and Expenses . If you are a cash basis taxpayer, as most individuals are, you may not take a bad debt deduction for expected income you have not received, since it was never included in your income. There are two kinds of bad debts - business and nonbusiness.

A business bad debt, generally, is one that comes from operating your trade or business. A business deducts its bad debts from gross income when figuring its taxable income. Business bad debts may be deducted in part or in full.

All other bad debts are nonbusiness. Nonbusiness bad debts must be totally worthless to be deductible. You cannot deduct a partially worthless nonbusiness bad debt. You must establish that you have taken reasonable steps to collect the debt and that the debt is worthless. It is not necessary to go to court if you can show that a judgment from the court would be uncollectible. You may take the deduction only in the year the debt becomes worthless. A debt becomes worthless when the surrounding facts and circumstances indicate there is no longer any chance the amount owed will be paid. You do not have to wait until the debt comes due.

A nonbusiness bad debt is reported on Form 1040, Schedule D (PDF) , Capital Gains and Losses, as a short-term capital loss. It is subject to the capital loss limit of $3,000 per year. This limit is $1,500 if you are married filing a separate return. A nonbusiness bad debt requires a separate detailed statement attached to the schedule D. For more information on nonbusiness bad debts, refer to Publication 550, Investment Income and Expenses . For more information on business bad debts, refer to Publication 535, Business Expenses .

References:

• Publication 535, Business Expenses
• Publication 550, Investment Income and Expenses
• Form 1040, Schedule D (PDF), Capital Gains and Losses

Since hobby expenses are deductible only to the extent of hobby income, it is important to distinquish hobby expenses from expenses incurred in an activity engaged in for profit. In making this distinction, all facts and circumstances with respect to the activity are taken into account and no one factor is determinative. Among the factors which should normally be taken into account are the following:

Additional information on this topic is available in section 1.183-2 (b) of the federal tax regulations.

References:

• Treas. Req. 1.183-2 (b)
• Publication 535, Business Expenses

You would include the money in income and you would not write the amounts off as expenses. Only business related expenses can be deducted from your business income. It is recommended that you not mix business and personal accounts. This makes it easier to keep records.

References:

• Publication 535, Business Expenses

Meal expenses are deductible only if your trip is overnight or long enough that you need to stop for sleep or rest to properly perform your duties. The amount of the meal expenses must be substantiated, but instead of keeping records of the actual cost of your meal expenses you can generally use a standard meal allowance ranging from $30 to $50 in 2003 depending on where and when you travel.

Generally, the deduction for unreimbursed business meals is limited to 50% of the cost that would otherwise be deductible.

For more information on business travel expenses and restrictions, refer to Tax Topic 511 , or Publication 463, Travel, Entertainment, Gift, and Car Expenses, and Publication 1542, Per Diem Rates .

References:

• Publication 463, Travel, Entertainment, Gift, and Car Expenses
• Tax Topic 511, Business travel expenses
• Publication 1542, Per Diem Rates

The federal per diem rates for foreign locations (outside the continental United States, abbreviated as OCONUS, and including the per diem rates for Alaska, Hawaii, Puerto Rica, the Northern Mariana Islands, U. S. possessions, and all foreign locates) are published monthly in the Maximum Travel Per Diem Allowances for Foreign Areas. Your employer may have these rates available, or you can purchase the publication from the:

You can also access the federal per diem rates for CONUS localities on the Internet at http://www.policyworks.gov/perdiem . This website also provides a link to rates for localities OCONUS..

References:

• Revenue Procedure 2002-63 SEC 3.02
• Publication 1542, Per Diem Rates

To deduct expenses related to the business use of part of your home, you must meet specific requirements. Even then, your deduction may be limited.

Your use of the business part of your home must be:

The business part of your home must be one of the following:

Additional tests for employee use. If you are an employee and you use a part of your home for business, you may qualify for a deduction use. You must meet the tests discussed above plus:

Whether the business use of your home is for your employer's convenience depends on all the facts and circumstances. However, business use is not considered to be for your employer's convenience merely because it is appropriate and helpful.

*exceptions

You do not have to meet the exclusive use test if either of the following applies.

Form 1040, Schedule C (PDF) filers calculate the business use of home expenses and limits on Form 8829 (PDF) . The deduction is claimed on line 30 of Schedule C. Employees claim deduction for business use of home as an itemized deduction on Form 1040, Schedule A (PDF) .

For more information refer to Tax Topic 509 , Business Use of Home, or Publication 587 , Business Use of Your Home (Including Use by Day-Care Providers).

References:

• Publication 587, Business Use of Your Home (Including Use by Day-Care Providers)
• Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship)
• Form 8829 (PDF), Expenses for Business Use of Your Home
• Tax Topic 509, Business Use of Home

In general, if you use a part of your home for both personal and business purposes, no expenses for business use of that part are deductible. Exceptions apply for qualified day-care providers and for the storage of inventory or product samples used in your business. For additional information on business use of your home, refer to Tax Topic 509, or Publication 587, Business Use of Your Home (Including Use by Day-Care Providers).

References:

• Publication 587, Business Use of Your Home (Including Use by Day-Care Providers)
• Tax Topic 509, Business use of home

No, if you lease a car you use in business, you may use either the standard mileage rate or claim actual expenses, which would include lease payments. You cannot use both the standard mileage rate and the lease payments.

References:

• Publication 463, Travel, Entertainment, Gift, and Car Expenses
• Tax Topic 510, Business use of car

State and local sales tax paid on personal items is no longer an allowable itemized deduction on Form 1040, Schedule A (PDF), Itemized Deductions. If the auto is a business asset it is generally added to the basis and recovered through depreciation.

References:

• Publication 17, Your Federal Income Tax (For Individuals)
• Publication 535, Business Expenses

It has to be a personal property tax, not an excise tax, in order to deduct it. Deductible personal property taxes are only those based on the value of personal property such as a boat or car. The tax must be charged to you on a yearly basis, even if it is collected more than once a year or less than once a year. To be deductible, the tax must be charged to you and must have been paid during your tax year. Taxes may be claimed only as an itemized deduction on Form 1040, Schedule A (PDF), Itemized Deductions.

References:

• Publication 17, Your Federal Income Tax (For Individuals)
• Form 1040, Schedule A (PDF), Itemized Deductions

You must spread any advance lease payments over the entire lease period. You cannot deduct any payments you make to buy a car even if the payments are called lease payments. If you lease a car that you use in your business, you can deduct the part of each lease payment that is for the use of the car in your business. You cannot deduct any part of a lease payment that is for commuting to your regular job or for any other personal use of the car.

References:

• Publication 463, Travel, Entertainment, Gift and Car Expenses

You must spread any advance lease payments over the entire lease period. You cannot deduct any payments you make to buy a car even if the payments are called lease payments. If you lease a car that you use in your business, you can deduct the part of each lease payment that is for the use of the car in your business. You cannot deduct any part of a lease payment that is for commuting to your regular job or for any other personal use of the car.

References:

• Publication 463, Travel, Entertainment, Gift and Car Expenses

There may be instances in which you must determine whether your payments are for rent or for the purchase of the property. You must first determine whether your agreement is a lease or a conditional sales contract. If, under the agreement, you acquired or will acquire title to or equity in the property, you should treat the agreement as a conditional sales contract. Payments made under a conditional sales contract are not deductible as rent expense.

Whether the agreement is a conditional sales contract depends on the intent of the parties. Determine intent based on the facts and circumstances that exist when you make the agreement.

In general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true:

References:

• Publication 535, Business Expenses

If you lease equipment with the option to later buy the equipment, you must first determine whether your agreement is a lease agreement or a conditional sales contract. If, under the agreement, you acquired or will acquire title to or equity in the property, you should treat the agreement as a conditional sales contract. Payments made under a conditional sales contract are not deductible as rent expense. You would start depreciating the equipment on the date you acquired the equipment.

Whether the agreement is a conditional sales contract depends on the intent of the parties. Determine intent based on the facts and circumstances that exist when you make the agreement

In general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true.

References:

• Publication 535, Business Expenses

If you give business gifts in the course of your trade or business, you can deduct the cost subject to special limits and rules. In general, you can deduct no more than $25 for business gifts you give directly or indirectly to any one person during your tax year. Exceptions may apply. For additional information, refer to Tax Topic 512 and Chapter 28 of Publication 17, Your Federal Income Tax .

For additional information on this subject seeGifts.

References:

• Publication 463 , Travel, Entertainment , Gift, and Car Expense
• Tax Topic 512, Business entertainment expenses

In order to properly determine the correct treatment income and expenses, it is first necessary to classify the type of investment activity occurring.

An Investor buys and sells securities solely for their own account. They are not engaged in a trade or business. An investor's investment expenses are taken as miscellaneous itemized deductions on Form 1040, Schedule A (PDF) , subject to the 2% AGI limitations (with the exception of investment interest which is not a miscellaneous deduction but subject to its own special limitations). An investor's sale of securities results in capital gains and losses.

A Dealer in securities has inventories of securities that they hold for sale to customers in the ordinary course of their trade or business. Their business expenses are deductible as ordinary business expenses. A dealer doing business as a sole proprietor would deduct their expenses on 1040 Schedule C. A Dealer's sale of securities is reported as ordinary income.

A third classification is Trader . A Trader is in the trade or business of buying and selling securities for their own account. You are a trader in securities if you meet all of the following conditions:

The following facts and circumstances should be considered in determining if your activity is a securities trading business:

A trader's business expense are reported on Form 1040, Schedule C (PDF) , not as itemized deductions on 1040 Schedule A. The deductions are not subject to the limitations that apply to Schedule A (2% AGI limitation and special limits on investment interest). A trader gain or loss on sale of securities is reported as capital gain or loss on Form 1040, Schedule D (PDF) unless they have made the mark-to-market election.

If a trader has made a mark-to-market election, gains and losses are reported on part II of Form 4797 (PDF) as ordinary income. For information regarding the manner and timing of making the mark-to-market election, see Publication 550 , Investment Income and Expense or Revenue Procedure 99-17, 1999-1 CB 503.

The proper classification of your investment activities is important to determine how income and expenses are to be reported. Investors trade solely for their own account and do not carry on a trade or business. Their securities sales result in capital gain or loss and their deductible expenses are itemized deductions. Dealers sell securities to customers in the ordinary course of trade or business. Their sales result in ordinary gain or loss and their deductible expenses are trade or business expenses. Traders buy and sell securities frequently but have no customers. Their purchases and sales result in capital gain and loss, and their deductible expenses are trade or business expenses.

Even if you engage in extensive securities activities, you are an investor, not a dealer or trader, if you do not seek profit primarily in swings in daily market movements, and do not personally engage in or direct the purchases or sales. An investor trades for profit-motivated reasons such as long-term appreciation, dividends and interest. Whether the activities of an individual constitute trade or business or investment is determined from the facts in each case. These distinctions have been established through court cases.

If your trading activity is a business, your trading expenses would be reported on Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship) instead of Form 1040, Schedule A (PDF), Itemized Deductions. Your gains or losses, however, would be reported on Form 1040, Schedule D (PDF), Capital Gains and Losses, unless you file an election to change your method of accounting.

If your trading activity is a business and you elect to change to the mark-to-market method of accounting, you would report both your gains or losses on Part II of Form 4797 (PDF), Sales of Business Property .

A change in your method of accounting requires the consent of the Commissioner and can not be revoked without the consent of the Secretary. Though there is no publication specific to day traders, the details for traders in securities and commodities are covered in Internal Revenue Code Section 475 (f) and Revenue Procedure 99-17.

References:

• Publication 535, Business Expenses
• Form 3115 (PDF), Application for Change in Accounting Method

A business is generally an activity carried on for a livelihood or in good faith to make a profit. Rather than defined in the tax code, exactly what activities are considered business activities has long been the subject of court cases. The facts and circumstances of each case determine whether or not an activity is a trade or business. Basically, if your day trading activity goal is to profit from short-term swings in the market rather than from long-term capital appreciation of assets, if your income is primarily from the sale of securities rather than from dividends and interest paid on securities, and if you expect this income to be your primary income for meeting your personal living expenses, i.e. you do not have another regular job, then your trading activity might be a business.

For details about not-for-profit activities, refer to Publication 535, Business Expenses. That chapter explains how to determine whether your activity is carried on to make a profit and how to figure the amount of loss you can deduct.

If your trading activity is a business, your trading expenses would be reported on Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship) , instead of Form 1040, Schedule A (PDF), Itemized Deductions. Your gains or losses, however, would be reported on Form 1040, Schedule D (PDF), Capital Gains and Losses , unless you file an election to change you method of accounting.

If your trading activity is a business and you elect to change to the mark-to-market method of accounting, you would report both your gains or losses and your trading expenses in Part II of Form 4797, Sale of Business Property. See Publication 550, Investment Income and Expenses , for details.

A change in your method of accounting requires the consent of the Commissioner and can not be revoked without the consent of the Secretary. Though there is no publication specific to day traders, the details for traders in securities and commodities are covered in Internal Revenue Code Section 475 (f) and Revenue Procedure 99-17.

References:

• Publication 535, Business Expenses
• Publication 550, Investment Income and Expenses
• Form 3115 (PDF), Application for Change in Accounting Method

If your sole proprietorship business is inactive during the full year, it is not necessary to file a Form 1040, Schedule C (PDF), Profit or Loss from Business, for that year.

References:

• Publication 334, Tax Guide for Small Business
• Form 1040, Schedule C (PDF), Profit or Loss from Business

Generally inventory losses and gains must be run through the business (shown as sold on Form 1040, Schedule C (PDF), Profit or Loss from Business) when sold even after the business closes. If you cannot sell inventory because it has become obsolete or you have formed the intent to give up possession of the inventory without passing it on to someone else and suffer a loss, you may deduct such losses. If you use any remaining inventory for personal use after you go out of business, you cannot take a deduction for that inventory. If you give the remaining inventory away to a nonprofit organization, claim your deduction on Form 1040, Schedule A (PDF), Itemized Deductions. When you have business related expenses after your business has closed, you still may deduct these expenses.

References:

• Publication 535, Business Expenses
• Publication 544, Sales and Other Dispositions of Assets

To determine which form you should file for your business entity, select one of the following links:

. Publication 541, Partnerships

. Publication 542, Corporations

. Publication 3402 (PDF), Tax Issues for LLCs

. Publication 334, Tax Guide for Small Business

. Entities: Sole Proprietor, Partnership, Limited Liability Company/Partnership (LLC/LLP), Corporation, Subchapter S Corporation

References:

• Publication 541, Partnerships
• Publication 542, Corporations
• Publication 3402 (PDF), Tax Issues for LLCs
• Publication 334 Tax Guide for Small Business
• Entities: Sole Proprietor, Partnership, Limited Liability Company/Partnership (LLC/LLP), Corporation, Subchapter S Corporation

In general, ordinary and necessary business expenses are deductible on business return. However, there are some items that partnership and S Corporation do not deduct at the business entity level but rather at the partner or shareholder level. These are referred to as separately stated items. For a more complete explanation of business in general, see Publication 535 , Business Expenses Publication 541, Partnerships, and Instructions for Form 1120S.

References:

• Publication 535, Business Expenses
• Publication 541, Partnership
• Instructions for Form 1120S
• Instructions for Form 1065

The place where your loss is reported depends on how much is deductible, the type of loss, and the type of return you are filing. If your business deductions are more than your business income for the year, you may have a Net Operating Loss (NOL). You can use an NOL by deducting it from your income in another year or years. Partnerships and S Corporations generally cannot use an NOL. But partners or shareholders can use their separate shares of the partnership's of S Corporation's business deductions to their individual NOLs. For additional help, see Publication 541, Partnership, Publication 542, Corporation, Publication 925, Passive Activities and At-Risk Rules, and Publication 536, Net Operating Losses (NOLs) for individuals, Estates, and Trusts.

If you have a Capital Loss, it is generally from the sale or loss of investment property, a business, or a capital asset used in a business. Publication 544, on Sales and Other Disposition of Assets, will provide additional information on this subject.

Special Situations

S Corporations

In general, if an S corporation purchases a C Corporation at the end of the year and the C Corporation has a loss, the S Corporation does not get to claim the C Corporation loss. A C Corporation is a taxable entity in itself and gains and losses do not flow through to the shareholders.

S Corporation shareholder who hold stock at any time during the year may claim their proportionate share of corporate losses on their individual tax returns subject to certain limits. For more information about the limitations, see the instruction for Instructions for Form 1120S, Schedule K-1.

Partnerships

In general, a partner loss is allocated base on his/her percentage of ownership of the year. This percentage is referred to as the partner's distributive share. The partners' distributive share of items is reported to the partner on Schedule K-1 (Form 1065). A partner's distributive share of partnership loss is allowed only to the extent of the adjusted basis of the partner's partnership interest. A loss that is more than the partner's adjusted basis is not deductible. For additional deductibility of partnership losses, see Publication 541, Partnership, and Publication 925, Passive Activities and At-Risk Rules

References:

• Publication 541, Partnership
• Publication 542, Corporation
• Publication 925, Passive Activities and At-risk Rules
• Publication 536, Net Operating Losses (NOLs) for individuals, Estates, and Trusts
• Publication 544, Sales and Other Dispositions of Assets

Unfortunately, the answer to this question has many variables. Publication 541, Partnerships "Disposition of Partner's Interest" on Partnerships should provide the information needed.

References:

• Publication 541, Partnerships