The Tax Bite

Frequent trading is fine, and is acceptable in an IRA (given correct settlement periods.)Daytrading gets a bit more grey, even if you can settle it with cash. Watch ERISA problems for non-IRA employment plans, and UBIT problems in an IRA.

If you're trading as a trader, no other employment, and basically running a tax free business out of your IRA....you'll very likely have problems.

It comes down to the spirit of the law, and they've made it more clear in their recent rulings, after the big increase traders during the late 90's early 2k's.

 

What if you are trading in a margin account as a trading business, but you are also trading in an IRA in a similar fashion but not exactly the same given the restrictions on cash accounts (T+3 settlement, no shorting, etc.)?

Where are these IRS clarifications? Any links?

 

From greencompany site:

"There are restrictions on IRA investments.

IRA investment guidelines limit what investments can be made, and disallow “self-dealing” or “prohibited transactions.”

For more information on these guidelines see “The Dos and Don’ts of IRA Investing” by Robert Preston (see the entire article at http://www.aicpa.org/pubs/jofa/apr2000/preston.htm).

Some IRA investments are prohibited, while others are allowed but they generate “unrelated business income”, which leads to the payment of taxes (UBIT) on that income – even though the investment is made in a tax-deferred IRA account.

IRAs may not invest in life insurance and collectibles (art works, antiques and most precious metals).

Foreign investments should be limited to ADRs and domestic mutual funds.

Real estate investments are allowed providing your trustee is a qualified provider, he or she allows it and can navigate around complex rules.

When it comes to brokerage accounts, IRAs are “cash accounts” and may not use margin to buy stocks (or other forms of debt-leverage for purchasing stocks). If an IRA invests in a hedge fund or other investment company that uses leverage, that is tantamount to breaking the rule on the use of leverage. The consequence is the generation of UBI from the income in the hedge fund and taxes on that income (UBIT).

In the above article, Robert Preston writes, “With certain investments, IRA owners face other risks. The IRS can use portions of the IRC (sections 511–514) to tax a not-for-profit or a tax-exempt entity that conducts business unrelated to its original purpose. The rules cover income-producing “businesses” in tax-exempt entities, including trusts (IRA trusts under section 408(e)(1) that are considered businesses). Investments can lose their tax-exempt status and be taxed as business entities even though they operate in a tax-exempt environment. These rules relate only to investments the IRS considers “profit- producing” and camouflaged by tax-exempt entities such as using IRA funds to buy an interest in a cattle-breeding operation or to invest in a hedge fund that uses leverage to purchase securities. Both transactions generate unrelated business taxable income (UBTI).”

Do you owe taxes if you day trade your IRA?

Many traders are interested in actively trading their IRA accounts, even though they can’t use margin to buy stocks.

Some traders will enter and exit trades on a daily basis, similar to how they operate their day trading business in “taxable” accounts.

This raises an important question of great concern to many traders. Will the IRS consider day or swing trading in an IRA account a camouflaged “profit-producing” activity that is subject to UBTI?

Many traders may not mind paying taxes on their day trading gains in their IRA account, since they would have to pay similar taxes anyway in a taxable account. Their goal may be to tap additional sources of trading capital and they don’t mind losing the tax-deferral benefits. If a trader stops trading, then the future profit growth is tax-deferred in the IRA account."

I've used green for their tax service advice & returns, and find them giving excellent advice. I've read through hundreds of pages of tax code (not fun), to verify everything, as well. I've been through many rulings (not law.....but show how they "interpret"). I wish I had all the links.....but finding anything on goverment sites is almost impossible.

greencompany has many more tidbits about this under "trader education--retirement plans"

No plug, just usefull info, but I don't think Robert will mind me cutting and pasting.

I've read the same in the IRS rulings. It comes down to "trading to the level of a business" in a retirement account.

 

... don't you think you are getting a little "wrapped around the axle" with the IRA restrictions ... if you are day trading an IRA account, anything your reputable broker, as trustee, lets you trade (equities, options (only long), futures) should not be considered "sheltering a business".

Won't the IRS will look at the cash flows? Day trading securities does not require any external cash flows into an IRA (like a cattle business, real estate, etc. would).

From the IRS point of view - they will capture sufficient tax later (probably at a much higher tax rate than 36%) when you draw the money out, unless of course you trade your tax free money down to zero

 

Not a Roth IRA. Distribution are not subject to income tax.

 

I'm just the messenger. I don't agree or disagree with it....this is just how the IRS treats it. It's a UBIT issue for trad & roth IRAs.

Contact a CPA or read the laws & rulings yourself.

 

I read this too. It does raise an important question, but it is not answered anywhere as far as I can tell. It does not say with certainty that the IRS would consider it to be subject to UBTI, or am I misreading it?

 

IRS' capital gain rules have changed many times in the past years. I am not sure a April 2000's publication from a non-authority will still apply when anyone will actually starts getting disbursement from a traditional-IRA. Roth IRA's distribution is tax free if it meet's Roth-IRA's distribution criteria. If an IRA account starts violating cash accounts' rules by doing too much trading with unsettled cash, then the brokerage firm can put a 90-day restriction on the account.