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Strategies & Market Trends : IRS, Tax related strategies--Traders -- Ignore unavailable to you. Want to Upgrade?

To: David Wiggins who wrote (261)	3/29/1998 12:46:00 PM
From: Robert A. Green, CPA	Respond to of 1383

Answer- Investors can not defer gains on options by rolling them over as asked. We will do some more research to see if Traders as opposed to Investors may somehow be able to defer their option gains as asked. See full question and answer below. Question, Robert, I just ordered your guide tonight. Thanks for the effort. If you would be so kind, I have one question. I am up quite a bit on some ATI options for April, July, and Jan 1999. I plan on rolling them over into options farther out. Is there any way to do this or exercise these options without being subject to taxation on each transaction? Thanks in advance, and if this is covered in your manual, just refer me to the proper section, Regards, Dave Answer - Dave, we believe your question asked if you could dispose of appreciated property (stock options) without being taxed on the gain by exchanging it rather than selling it. In many cases, you can defer tax on your gain through the 'like-kind' exchange rules, but Investors can not apply these rules for securities including stock options (see below). We are still looking into a possible exemption for Traders (see below). We just added this question and answer to our tax guide Edition 5. Traders and Investors may order our entire 30+-page trader tax guide for same day email delivery by emailing your order to rgreen@greencompany.com After your email receipt of the guide, please mail us a check for $25 payable to Green & Company Inc. at 415 East 37th St, 39th floor, New York, NY 10016. If you would like to consult with Robert Green, CPA about your tax return call him at 212-684-4394. There is tons of free tax information for Traders and Investors at our Web site at greencompany.com Good luck with your tax returns. Answer explaining Like Kind Exchanges: A like-kind exchange is any exchange of property held for investment or for productive use in your trade or business for like-kind investment or trade or business property. For these purposes, 'like-kind' is very broadly defined. As long as the exchange is real estate (land and/or buildings) for real estate, or personalty (non-real estate) for personalty, it should qualify. However, some types of property (for example, inventory or shares of stock), cannot qualify. If you are unsure whether the property involved in your exchange is like-kind, please call and we can discuss the matter. Assuming the exchange qualifies, here's how the tax rules work: If it's a straight asset-for-asset trade, you will not report any gain from the exchange. You will take the same basis in your new property that you had in the old property. Frequently, however, the properties are not equal in value so some cash or other (non-like-kind) property is tossed into the deal. This cash or other property is known as 'boot.' If boot is involved, you will have to recognize your gain, but only up to the amount of boot you receive in the exchange. And in these situations, the basis you get in the like-kind property you receive is equal to the basis you had in the property you gave up reduced by the amount of boot you received but increased by the amount of gain recognized. Example. Ted exchanges land (investment property) with a basis of $100,000 for a building (investment property) valued at $120,000 plus $15,000 in cash. Ted's gain on the exchange is $35,000: he received $135,000 in value for an asset with a basis of $100,000. However, since it's a like-kind exchange, he only has to recognize $15,000 of his gain: the amount of cash (boot) he received. And Ted's basis in his new building will be $100,000: his original basis in the land he gave up ($100,000) plus the $15,000 gain recognized, minus the $15,000 boot received. Note that no matter how much boot is received, you will never recognize more than your actual ('realized') gain on the exchange. Impact of debt. If the property you are exchanging is subject to debt from which you are being relieved, the amount of the debt is treated as boot. The theory is that if someone takes over your debt it's equivalent to their giving you cash. Of course, if the property you are receiving is also subject to debt, then you are only treated as receiving boot to the extent of your 'net debt relief' (the amount by which the debt you are freed of exceeds the debt you pick up). Like-kind exchanges are an excellent tax-deferred way to dispose of investment or trade or business assets. If you have additional questions or would like to discuss the topic further, please call. Are Traders subject to the limitation on using like kind exchanges mentioned above that certainly does apply to Investors - we are working on this question - see a future post: One good idea for all of us to think about is if a Trader in Securities may somehow be able to claim that the securities limitation stated above should not apply to them. Answer about Deferred Like Kind Exchanges You recently asked about the tax treatment of a 'deferred' like-kind exchange in which there is to be a delay in your receipt of the like-kind property. If the transactions involved are carefully timed to meet the like-kind exchange requirements, you should be able to defer all or part of your gain on the exchanged property. A deferred exchange may be necessary where you find a 'customer' who wants your property but who has not yet acquired property to turn over to you in exchange. Or perhaps you have not yet determined your needs for replacement property and seek a delay in determining what property to accept in exchange. Under the like-kind exchange rules, you can structure a deferred (nonsimultaneous) exchange. You transfer your property to the other party but defer your receipt of replacement property. To qualify, the following time limits must be met: 1 The property you are to receive must be 'identified' no later than the day that is 45 days after your property is transferred. Identification should be made in writing and clearly describe in appropriate detail the property to be transferred. 2 The actual transfer must occur no later than the earlier of: a the day 180 days after your property is transferred, or b the due date (including extensions) of your tax return for the year in which you gave up your property in the exchange. Be careful with this Requirement #2. If you transfer your property in the exchange late in the year do not automatically assume you have 180 days to receive the replacement property. Say you transfer your property on December 10th. If you do not get an extension for filing your tax return, you will have to receive the replacement property in exchange by April 15th, which is earlier than the day which is 180 days after December 10th. Of course, in this case, a filing extension will give you additional time. Note, however, that no extensions can be obtained on the 45-or 180-day periods themselves. Alternative arrangements. If the time limits outlined above are too restrictive in your case, we may be able to work out alternative arrangements which effectively give the exchanging party more time to come up with the replacement party. These arrangements can involve: a leasing your property to the other party for a period rather than transferring it outright, b granting an option to buy your property to the other party which could be exercised when the replacement property becomes available, or c transferring your property to an independent trust or escrow arrangement to be held until the exchange can be made. 22,382 How the like-kind rules have been applied to exchanges of miscellaneous real property interests. The following exchanges of real property qualify as like-kind exchanges: . . . Improved real estate for unimproved real estate. 36 . . . City real estate for a farm or ranch. 37 . . . Rental real property (land and improvements) for farm real property (land and improvements). 38 . . . Rental house in the U.S. for rental condominium unit in the U.S. Virgin Islands. The rule barring like-kind exchanges of U.S. and foreign real property doesn't apply, because under Code Sec. 932, the term "U.S." is expanded to include the U.S. Virgin Islands. 39 . . . Fee simple interests in real property for fee simple interests in other real property subject to 99-year condominium leases. The leases didn't disqualify the exchange since the exchanged interests were perpetual in nature, and thus they met the "duration-of-the-rights" test (see 22,381). 40 . . . Real property containing a sand mine for commercial rental property. 40.1 . . . Commercial building for a condominium interest in a newly constructed commercial building, provided that the condominium interest includes a common interest in the underlying land. 41 . . . Cooperative housing corporation stock for condominiums in the same physical property, where the co-op tenant-shareholder's interest included a lease that ran for more than thirty years and applicable local law characterized a tenant-shareholder's interest and a condominium interest as the ownership of real property. 42 . . . Timberland for bare land. 42.1 . . . Timberland for other timberland differing in quality and quantity of timber. 43 . . . Timberland, with a reservation of timber-cutting rights, for state-owned timberland of lesser fair market value. 44 . . . Real property subject to an option to purchase held by a third party for real property not so subject, where all parties had notice of the option and full legal title to the optioned property was transferred under local law. 45 . . . Real property subject to a lease for real property not so subject. The existence of the lease affects the grade and quality of the property rather than its nature and character. 46 . . . Property A (unencumbered farm lands, farm buildings and unharvested crops) for Property B (unencumbered farm lands, farm buildings and unharvested crops). 47 . . . Lease interest of less than 30 years for similar lease-hold interest. Thus, the assignment of a corporation's building lease that had 27 years to run in return for cash and an identical lease in a part of the same building was a like-kind exchange. 48 For exchanges involving leasehold interests of 30 years or more, see 22,385. . . . Farm land belonging to an incompetent for other farm land, even though the exchange took the form of a cash sale and purchase because it involved an incompetent person and local law permitted no exchanges by guardians. 49 36 Reg 1.1031(a)-1(b). 37 Reg 1.1031(a)-1(c); Braley, E.R., (1929) 14 BTA 1153, acq1929-2 CB 6. 38 Rev Rul 72-151, 1972-1 CB 225. 39 IRS Letter Ruling 9038030. 40 Koch, Carl, (1978) 71 TC 54, acq1979-2 CB 2. 40.1 Beeler, Larry L., (1997) TC Memo 1997-73, RIA TC Memo 97073, 73 CCH TCM 1982. 41 IRS Letter Ruling 8938045. 42 IRS Letter Ruling 8810034; IRS Letter Ruling 8445010; IRS Letter Ruling 8443054. 42.1 Rev Rul 78-163, 1978-1 CB 257. 43 Rev Rul 72-515, 1972-2 CB 466. 44 Rev Rul 76-253, 1976-2 CB 51. 45 Boise Cascade Corp, (1974) TC Memo 1974-315, PH TCM 74315, 33 CCH TCM 1443. 46 Boise Cascade Corp, (1974) TC Memo 1974-315, PH TCM 74315, 33 CCH TCM 1443. 47 Rev Rul 59-229, 1959-2 CB 180. 48 Rev Rul 76-301, 1976-2 CB 241. 49 Rev Rul 57-469, 1957-2 CB 521.

To: David Wiggins who wrote (261)	3/29/1998 12:58:00 PM
From: Robert A. Green, CPA	Read Replies (2) \| Respond to of 1383

TRADER TAX RULES & TAX RETURN REPORTING GUIDE - EDITION 5 - Free Excerpt Traders and Investors may order our entire 31-page trader tax guide for same day email delivery by emailing your order to rgreen@greencompany.com After your email receipt of the guide, please mail us a check for $25 payable to Green & Company Inc. at 415 East 37th St, 39th floor, New York, NY 10016. If you would like to consult with Robert Green, CPA about your tax return call him at 212-684-4394. There is tons of free tax information for Traders and Investors at our Web site at greencompany.com Good luck with your tax returns. Free Excerpt Table of Contents ...Tax benefits for Traders, tax penalties for Investors ...A step by step Tax Forms Guide for Traders ...Executive Summary for Traders ...A definition of a Trader by CCH and RIA ...Distinguishing characteristics of a Trader ...Tax Research - Whether taxpayer is a trader or an investor ...Tax Research - Traders in securities -- a business or investment activity? ...Tax Research - Whether a taxpayer managing his own investments is in a trade or business ...How a trader may elect the new mark-to-market accounting method to get unlimited ordinary losses on Schedule C ...Wash sales apply to investors but not to traders electing mark to market rules ...How to avoiding the hobby-loss restrictions from a Schedule C trading loss ...Like Kind Exchanges - Investors may not defer gains on stock options by replacing them with new contracts with longer expiration dates. Traders may in very limited cases be able to do so Tax benefits for Traders, tax penalties for Investors "Traders" are not treated as "investors" or as "dealers." They have special hybrid treatment under the IRS tax code. - The new tax law of 1997 passed some attractive new rules for traders electing the new mark-to-market accounting method. 1. Investors are penalized on their taxes because they can not deduct more than $3,000 of net capital losses in any given tax year. Many active traders have significant losses in 1997, especially paper losses at the end of year. They are being forced to pay large tax bills on April 15, 1998 because they think their losses are limited and they can not take their paper losses. Relief - Traders electing the new 1997-tax law "mark-to-market accounting method" may deduct an unlimited amount of year-end unrealized trading losses as ordinary losses. a. The new law states that, "for tax years ending after August 5, 1997, traders in securities or traders in commodities may elect the same mark-to-market treatment that applies to dealers in securities, except that a trader does not maintain an inventory that must be marked to market." According to RIA (see below in bold), "the trader recognizes gain or loss on any security held in connection with the trade or business at the close of any tax year as if the security were sold for its fair market value on the last business day of the tax year, and (Code Sec. 475(f)(1)(A)(i)) any gain or loss is taken into account for the tax year. Any gain or loss recognized by an electing taxpayer is ordinary gain or loss. (Com Rept, see 5111). b. I don't think taxpayers should push the envelope on this issue until it is further clarified. If you take an unrealized trading loss on Schedule C and the result is a large overpayment credit, I suggest you do not claim a refund but rather apply any overpayment credit to the following tax year's estimated taxes. Feel free to consult with us on this issue. 2. Investors are penalized by being allowed to deduct only certain limited types of investment expenses. For investors, margin interest expenses are limited to investment income, which in effect doesn't allow the interest deduction if you have few dividends and capital losses. Traders can deduct unlimited amounts of trading expenses and interest expenses on Schedule C- no limitations or restrictions of any kind. 3. Investors receive long-term capital gains tax rate treatment. Traders also receive long-term capital gains tax rate treatment. Traders electing the new mark-to-market accounting method have ordinary gains and losses. Mark-to-market traders can still designate trading positions as capital rather than ordinary positions, and then hold those positions for long-term to rates. Most traders don't hold positions over 12-months anyway. 4. Investors are not subject to self-employment taxes on capital gains. Traders are also not subject to self-employment taxes on capital gains. Traders electing the mark-to-market accounting method convert capital gains to ordinary gains that are reportable on Schedule C, rather than on Schedule D. A Trader's Schedule C net income is considered earned income subject to self-employment taxes and available for retirement account contributions. a. For tax year 1997, many traders have mark-to-market losses at year-end due to the declining year-end securities markets. Therefore, their mark-to-market positions probably result in ordinary losses rather than ordinary gains. In those cases, self-employment tax is not an issue for them in 1997. b. For 1998, an electing mark-to-market trader in securities can form and trade through an S-Corporation and thereby not be subject to future self-employment taxation on this ordinary income. S-Corp gains or losses flow-through to their owner's individual income tax returns. Flow-through income from a Schedule C, partnerships, and Limited Liability Companies (LLCs) is considered earned income (for owner/managers) for self-employment tax purposes. Our firm incorporates many new S-Corps and other legal entities through BizFilings (see our Web site greencompany.com, go to Legal & Incorporation, go to e*Commerce tax guide, go to Cybercorps). In our opinion, using an S-Corp. for your trading reduces IRS scrutiny (versus a Schedule C), gives you legal protection, and allows you to take more business expenses (contact us about this point). 5. Investors are subject to the wash sale rules. Traders electing the mark-to-market accounting method under the new 1997 tax law are not subject to the wash sale rules. 6. The IRS rules listed below are clear in subjective terms but not clear in objective terms. The tax courts have issued many ruling over the years that frame the objective tests. We strongly feel recent advances in the Internet and on-line trading brokerage firms have made the trader business much easier to operate. There are now over 4 million on-line trading accounts in the U.S. and many of these traders are very active in the business of trading in securities. Some of these active traders may qualify for the "trader" tax treatment and it could be very advantageous to them under certain conditions. Tax Forms Guide for Traders versus Investors 1. Traders and Investors both use Schedule D to report all capital gains and losses on "realized" sales of securities during the tax year. 2. Traders electing the mark-to-market accounting method may report their year-end "unrealized" gains and losses on Schedule C. Traders would probably choose this option if they have unrealized losses. We have some reporting strategies in connection with this area, so contact us for a consultation on your specific tax situation. a. I suggest that Traders electing the mark-to-market accounting method report their unrealized ordinary trading gains or losses on Schedule C, Part I, line 6 "Other Income." Losses should be reported as a negative number on this income line. b. Trading losses are not expenses and should not be reported in Part II "Expenses." Trading losses are also not Costs of Goods Sold (inventory) and should not be reported in Part I, line 4 "Cost of Goods Sold." c. On Schedule C, I suggest you use the business Code # 5777 for "Other Financial Services". A trader is not a "broker & dealer of securities" or a "commodity broker or dealer." A trader is also not in business services. 3. Investors report investment expenses on Schedule A subject to investment interest expense restrictions and miscellaneous investment expense limitations and restrictions. Traders report all trading business expenses on Schedule C. By reporting realized capital gains and losses on Schedule D, and trading expenses and excess unrealized trading losses on Schedule C, your Schedule C shows a net loss. This can invite IRS questions about "hobby losses" (see hobby loss rules at the end of this guide). a. The way to solve this matter is to explain in your memo that you are a Trader in Securities with your realized capital gains and losses reported on Schedule D by law and your trading expenses and excess unrealized losses reported on Schedule C by law. After you combine your Trader gains, losses and expenses from both Schedules D and C you show that you are not subject to hobby loss rules as follows. b. There are two ways to avoid the hobby loss rules. The first way is to show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing, or racing horses). The second way is to run the venture in such a way as to show that you intend to turn it into a profit-maker, rather than operate it as a mere hobby. The IRS regs themselves say that the hobby loss rules won't apply if the facts and circumstances show that you have a profit-making objective. A serious on-line trading business is not a hobby. 4. Both investors and traders with many transactions during the year may instead of reporting every trade during the year, use one line item for each holding period - example, "eSchwab - nominee (detail of trades available on request)." Contact us for some other line-by-line guidance as well as the explanatory note to put in with your tax returns.