Tax Advantages of Day Trading Through Self-Directed IRAs
Much of the tax hassle associated with day trading is eliminated if you trade through a self-directed Individual Retirement Arrangement, or IRA. Most brokerage firms can set them up for you and handle the necessary paperwork.
Although individuals can contribute only $5,000 per year ($6,000 for people older than 50), the money can be substantial for those who have been contributing for a long time. Also, you can roll over money from an employer’s retirement plan, such as a 401(k), into an IRA after you leave.
You don’t have to pay taxes in an IRA until you retire, and then withdrawals are generally treated as ordinary income. For this reason, an IRA is a great vehicle for day traders: You can post big gains, count all your losses, and avoid wash-sale rules for trading within your IRA. It’s a sweet way to let your profits accumulate and compound for years.
Of course, there’s a catch: You can’t sell short, you can’t use all options strategies, and your brokerage firm may not want to clear funds through the IRA.
If you are a full-time trader, consider keeping your retirement fund completely separate from your trading funds. That way, you can pay the bills in your golden years without worrying about what happens every trading day. It’s a way to reduce stress, plus many retirement funds have tax benefits that may help the bottom line on your trading business.
You can’t withdraw money from an IRA account until you turn 59-1/2. If you take money out earlier, you pay a 10-percent tax penalty, and that offsets a lot of the advantages. If you need income from your trading activities to cover your living expenses before then, an IRA is probably not the best way to set up your day trading account.