Can Self-Managing Investors Deduct Related Expenses?

In some cases, investors have significant related expenses, such as the cost of subscriptions to financial periodicals and clerical expenses. Are they tax deductible?

Under the Tax Cut ans Jobs Act (TCJA), expenses cannot be deductible through 2025 if they’re considered expenses for the production of income. But they can be deductible if they’re considered trade or business expenses.

For tax years before 2018, production-of-income expenses were deductible, but were included in miscellaneous itemized deductions, which were subject to a 2%-of-adjusted-gross-income floor.

In order to deduct investment-related expenses as business expenses, you must figure out if you’re an investor or a trader. Be aware that it’s more advantageous (and difficult) to qualify for trader status.

Investor or Trader?

To qualify, you must engage in a trades or businesses. The U.S. Supreme Court states that an individual taxpayer isn’t engaged in a trade or business merely because the individual manages his or her own securities investments, regardless of the amount of the investments or the extent of the work required.

You may be considered a trader engaged in a trade or business, rather than an investor, if you can show that your investment activities rise to the level of carrying on a trade or business. For traders, you’re entitled to deduct your investment-related expenses as a business expense. If the home office is used on a regular basis as the trader’s principal place of business, trader’s can deduct home-office expenses. Investors aren’t entitled to home-office deductions since the investment activities aren’t a trade or business.

For more information about being a trader or investor, visit https://yourwealthknowledge.com/trader-or-investor/

Two Part Test

Since the Supreme Court’s decision, there’s been litigation on the issue of whether a taxpayer is a trader or investor. In order for a taxpayer to be a trader, the U.S. Tax Court came up with a two-part test must be satisfied .

Under this two-part test, taxpayer’s investment activities are considered a trade or business, but only if both of the following are true:

  • The taxpayer’s trading is substantial (in other words, sporadic trading isn’t a trade or business), and
  • The taxpayer seeks to profit from short-term market swings, rather than from long-term holding of investments.

The fact that a taxpayer’s investment activities are regular, extensive and continuous isn’t in itself sufficient for determining that a taxpayer is a trader. In order to be considered a trader, you must show that you buy and sell securities with reasonable frequency in an effort to profit on a short-term basis.

In one case, taxpayers who made more than 1,000 trades a year with trading activities averaging about $16 million annually were an investor.

Contact us if you have questions about whether your investment-related expenses are deductible. We can also help explain how to help keep capital gains taxes low when you sell investments.