Trader Tax Misconceptions


Filing your taxes from stocks and options trading can be a daunting task, especially when it comes to filling out an accurate schedule d. And it may come as no surprise that the IRS schedule d is one of the most complicated of any of the current IRS tax forms!

With today’s easy access to online stock and option trading, many individuals find themselves having to deal with hundreds or even thousands of trade transactions that need to be reconciled and entered on their schedule d at year end. The days of buying one or two stocks per year and then selling once every couple of years to replace lower performing stocks are virtually gone.

But what is of more concern is that many traders over-simplify this complex task. There is an enormous amount of misinformation floating around the web about how to accurately prepare your capital gains or losses from investing or trading, and using this to file your taxes.

Here are some of the more popular misconceptions:

  • I can report my gross sales, total costs, and net gain or loss as one line item on my schedule d.
    This is wrong and the IRS has taken a strong stand on this the last few years.
    See Tax Update by Ed Zollars, CPA. We have had many users purchase our TradeLog software because they reported their trading gains this way and are now being audited for previous tax years.
  • I can take my broker provided gain or loss statement and use that as my schedule d details. This also leads to trouble as most broker provided gain or loss statements are inaccurate!
    I know this is hard to believe, but please read on.
  • I can import my trades directly from my broker into any popular tax software program and get an accurate schedule d.
    This too is wrong because in most cases the data imported comes from the brokers inaccurate gain or loss statement.
  • My tax software calculates wash sales.
    None of the popular "made for the masses" tax software programs calculate wash sales.  They depend on the imported brokerage data to do this and most broker provided statements do not provide wash sale calculations. Those that do usually are in error and may over or understate your disallowed losses.

Broker provided Gain/Loss reports

Let's take that second misconception that all you need is your broker provided Gains and Losses (or profit and loss) statement. The first problem with this approach is that these statements are notoriously wrong. 

Your broker provides bold disclaimers that these reports are for informational purposes only and should not be used for tax purposes. Here is a sampling of such disclaimers: 

"This information may not include all adjustments necessary to be made prior to its use in the preparation of your tax return."

"Such information may not reflect all adjustments which may be necessary for tax reporting purposes"

"Be sure to verify the information that you import against your own records in order to insure accurate and complete reporting of all required tax information on your federal income tax return."

"This statement is being provided for informational use only. Please review it carefully for errors. It may or may not represent the amount of gain or loss reportable by you for Federal and state income tax purposes."

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So what are we to make of such broker provided Gain/Loss statements?  
They are not always accurate and therefore should not be the sole source for your trade details as required by the IRS for schedule d reporting of capital gains.

Please let me illustrate some of the problems:

A real life example:

A certain trader made approximately 80 round trip trades in 2007. His broker provided Gain/Loss report showed a net loss of $1,909.87

The same trader imported from his brokerage account into TradeLog after manually entering his 2 positions carried open from 2006. He was able to see each and every trade that he made throughout the year in the exact order that he traded them, verified his open positions at year end and reconciled to his 1099 to the penny. TradeLog also properly calculated his wash sales and no losses were disallowed for 2007 and deferred to 2008.

TradeLog calculated a net gain of $3,392.01. Why the difference?

One mistake that was easy to spot was for Altria Group (MO) where he held 257 shares open from 12/15/2006 and where his broker G/L statement did not pick up this open position:

If you look at the above section of this report, there is no indication that anything was missing and the 200 share purchase from 02/26/2007 seems to match quite well with the sale on 03/01/2007.

But since he had 257 shares open from last year, the first sale in 2007 dated 03/01/2006 needs to use the open position cost basis of 200 of these shares for calculating it's gain or loss. The cost basis on the balance of the 57 shares is used as part of the cost basis of the very next sale of 357 shares made on 04/09/2007.

This was easy for us to spot because we have been doing this for 8 years. We also compared that with what TradeLog recorded:

This now results in the following correct entries on schedule d:

When open positions are missing from the G/L statement it throws off the trade matching for the entire gain and loss report.  Everything needs to be shifted due to the IRS first-in, first-out (FIFO) trade matching rules.

But the real problem is that there is NO WAY for this trader to know that something was wrong by just looking at his statement!  He was given a false sense of security when he depended on his broker to provide an accurate report of his trading gains and losses.

Miscalculated Wash Sales
This brings up another interesting miscalculation on this report: An erroneous Wash Sale Disallowed Loss adjustment was made in the above Gain/Loss report for Altria Group mainly due to the missing open position information.

This particular broker Gain/Loss statement is quite unique however, in that they made an attempt to calculate wash sales. Most brokers do not calculate wash sales in their Gain/Loss reports which is an IRS requirement. But if they did, as we can see from this example, it only compounds the problem.

In addition, if you had more than one brokerage account, wash sale calculations may be further in error because wash sales must be calculated across all brokerage accounts.  Are you starting to see how easy it can be to misrepresent your true capital gain or loss from trading?

Now what if you use one of the popular tax software programs?  Does this help ease the pain?
Please follow along for the answers:

Popular Tax Software

Popular tax software programs were never designed for the needs of active traders or serious investors. Therefore they should never be used for filling out your schedule d.

What you need is a software program that imports from the raw buy/sell transactions; that is able to match those buy/sell transactions properly; that allows you to make adjustments as necessary; that allows you verify that everything is correct; that allows you to combine accounts from multiple brokers; and that then, and only then, calculates wash sales.

The same trader mentioned above imported his trades into TurboTax. There were no errors due to missing cost basis and everything flowed perfectly into TurboTax.. Both his broker Gain/Loss statement and TurboTax reported a net loss of $1,909.87. Basically TurboTax took the broker provided G/L data verbatim and there was absolutely no indication that anything was wrong!

As we have shown in our real life example above, he actually had a net gain of $3,392.01.

But is it possible to fix the problem? Could he possibly enter his two open positions from 2006 into TurboTax and then rematch everything? Not on your life, because such tax programs depend on the broker import data to do this for you. Unless he wants to remove all the imported transactions and manually enter all his trades, he simply has no way to accomplish this.

Add to that the fact that he now has no way to automatically calculate his wash sales. Yes, you may be able to flag a loss trade as a wash sale in TurboTax, but who wants to scan your entire list of matched trades to see if there are any wash sales? 

And what if you did not repurchase an equal number of shares as the loss trade?
For example, what if you sold 1,000 shares at a loss of $1,000 and only bought back 200 shares within the 30 day window and held these shares open at year end? You certainly do not want to defer the entire $1,000 loss to next year do you?  The correct deferral is only $200. There is no way to easily handle this in TurboTax.

Here are a few other real life examples:

Example #1:

A certain trader at an online brokerage completed approximately 40 round trip trades in tax year 2006. This resulted in 209 trade records (buy/sell transactions) for the year due to partial fills.

After just a few clicks to connect to their online broker’s web site and importing their 2006 trade records into their “tax software” our active trader was confronted with the following error: “42 sales do not have a cost basis or date acquired entered.”

So after importing only 209 trade records, 42 of them were not matched properly (no cost basis was found) by this popular tax software program.

At this point in time our trader is provided absolutely no assistance to help him find out what is wrong, or most importantly, how to fix things. Incidentally, this trader started 2006 with only 4 open positions, and only 5 open positions at year end, so something is drastically wrong here.

Example # 2:

Now let’s get a little more drastic. Another trader at the same online brokerage completed approximately 500 trades in tax year 2006. This resulted in 2,513 trade records (buy/sell transactions) for the year.

Did he fare any better:

A whopping 798 sales out of a total of 1,202 sales records were found to be missing matching purchases (no cost basis). And since this trader had no open positions going into the 2006 tax year, and only 2 open positions at year end, something is even more wrong here.

Made for the masses doesn’t cut it!
So right from the start, we can see that using such “made for the masses” tax tools doesn’t cut it when it comes to handling the needs of active traders, or even less active traders. Then why do so many online brokerages offer such tools in their tax centers?  - We’re not quite sure.

Manually enter your trades?
Ok, so maybe we can enter our trades manually. Well most traders do not buy and sell in equal share increments. For example, what if you purchased 1000 shares of a stock on a certain day, then sold 300 shares one day later, 200 shares another day, then you bought another 500 shares a week later, then you sold 700 shares two days later and finally you sold the last 300 shares a few days later?

How does all this divide up on schedule d?  And what about calculating wash sales? It boggles the mind just thinking about it. And wouldn’t this defeat the whole purpose of an automated tax software program in the first place? So what is a trader to do?

Purchase professional grade trader tax software that was designed first and foremost for the needs of active traders. TradeLog trade accounting and tax software is such a software program.

TradeLog® was designed by active traders, for active traders. But even the casual investor who has 40 or 50 trade records in a year can benefit as well.

TradeLog can import an entire year with just a few clicks and it does so from your online brokerage trade history report, not the inaccurate Gains/Losses report. It allows you to first enter any open positions from last year, and then it goes to work matching each and every trade with speed and precision.

But what if something is “out of whack” and gets mismatched?  No problem, TradeLog has an extensive suite of editing tools and powerful trade matching algorithms that make finding and correcting such things a breeze.

Here are those two example accounts above had they used TradeLog:

Example #1:

First we manually enter our 4 open positions from 2005:

Then we import our trades for all of 2006 and Jan 2007 (Jan 2007 trades are required to accurately calculate wash sales).

Again, there were zero mismatches, therefore all we need to do is run and print the IRS ready schedule d-1:

The totals on the last page of this schedule d-1 attachment get entered on your schedule d:

Now you can run the TradeLog “End Tax Year” procedure which will create your 2007 data file, all ready for importing next year’s trades.  And you do not have to wait till year end to do so. You can import whenever and however often you want and TradeLog will keep you up to date.

Example # 2:

What about the guy with 2,500 transactions?  He had no open positions, so he went straight to the import:

He also had zero adjustments to make, so all that was left was to run the IRS schedule d-1 report:


Popular tax software programs do not properly handle the wash sale rule.

A severe limitation of most tax programs is their inability to handle wash sales on unequal share amounts. For example: if you sell 1,000 shares at a net loss of $1,000 and then within 30 days you repurchase 200 shares of the same stock, the IRS says that only a portion of the loss is adjusted for wash sales.

Unequal Share Example:

  1. On 12/12/2006 you sold 1,000 shares at a net loss of $1,000.
  2. On 12/28/2006 you repurchased 200 shares of the same stock and held these shares open till next year.

The total wash sale amount adjusted should be: 200 shares / 1,000 shares x $1,000 = $200

Yet popular tax software programs can only make wash sale adjustments on the full share quantity of 1,000 shares or $1,000. So if the repurchase shares are left open at year end or they were repurchased in January of next year, then you would have a disallowed loss of $1,000 instead of $200.The net effect of this is that you would pay taxes on $800 more than you should have.

But it can get even more complicated:

  1. On 12/29/2006 you bought back 350 shares of the same stock
  2. On 01/05/2007 you bought back 1,000 shares

Popular tax software programs simply were never designed for such complex wash sale scenarios. Yet, such scenarios are quite common for the casual investor as well as the active trader.

TradeLog™ software was designed to handle such complex scenarios and more.

HAPPY TAX SEASON - END OF STORY!