I purchased a computer last year to do online day trading part-time
from home for additional income. Can I deduct or depreciate the cost of the
computer or internet connection from my investment income?
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.
The entire acquisition cost of a computer purchased for business use can
be expensed under Code section 179 in the first year if qualified, or depreciated
over a 5-year recovery period. Under section 179, you can elect to recover
all or part of the cost of certain qualifying property, up to a dollar limit,
by deducting it in the year you place the property in service. You can elect
to expense the cost of qualifying property instead of recovering the cost
by taking depreciation. To claim the expense in the first year, the property
must be used more than 50% for business use (as opposed to investment use),
and meet the other requirements for expensing. One of those requirements is
that the total cost of qualifying property you can deduct after you apply
the dollar limit is limited to the taxable income from the active conduct
of any trade or business during the year. Any cost not deductible in one year
under section 179 because of the business income limit can be carried to the
next year.
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 section 179 deduction.
Because these deductions are for investment expenses rather than for business
expenses, 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 (including the special depreciation)
for it. For more information, refer to "Listed Property" in Publication 946, How
to Depreciate Property.
Can I deduct my investment expenses as business 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
Form 1040 Schedule C. A Dealer's sale of securities is reported as ordinary
income.
A third classification is Trade. 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:
- You must seek to profit from daily market movements in the prices of securities
and not from dividends, interest, or capital appreciation.
- Your activity must be substantial.
- You must carry on the activity with continuity and regularity.
The following facts and circumstances should be considered in determining
if your activity is a securities trading business:
- Typical holding periods for securities bought and sold.
- The frequency and dollar amount of your trades during the year.
- The extent to which you pursue the activity to produce income for a livelihood
- The amount of time you devote to the activity.
A trader's business expense are reported on Form 1040, Schedule C (PDF), not as itemized deductions on Form 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 cannot 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.
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