Lessons from the Pros


Complete Guide to Mark-to-Market Election

Last month in our article on Know Your Trader Tax Terminology, I brought up the Mark-to-Market Election which sparked several questions revolving around this topic. This guide to the Mark-to-Market Election should clear things up.

What is Mark-to-Market?

Securities that are Marked-to-Market are taxed on realized (what you sold) and unrealized (still open) gains or losses at the end of the year.  Forex and futures are marked-to-market.  This means you may pay tax on how much your account is up, even though those positions have not been sold yet.

Why Elect Mark-to-Market?

There are some timing considerations and strict IRS guidelines to consider when determining whether Mark-to-Market will benefit you. However, there are several compelling reasons to choose the Mark-to-Market election.

  • Unlimited Losses
    Having no $3,000 capital loss limit is very appealing for a trader who had a $10,000 “learning curve”.  For the trader who does not elect Mark-to-Market timely, a $10,000 loss means deducting only $3,000 this year and using the remaining $7,000 to carry forward to offset future gains.  But the Mark-to-Market trader can deduct the loss entirely.  No capital loss limit!  No capital carryovers!If the loss fully exhausts your other taxable income, such as Wages or Pension Income, then you might even have a Net Operating Loss (NOL) to carry forward for future years or backwards to prior years.
  • Get Rid of Wash Sales
    If you sell and buy a similar security (based on ticker) within 30 days, you created a wash sale.  Back in the 20s, the IRS realized some investors would sell their losing stocks on the last day of the year only to repurchase them at the same price the next day, all to report a temporary tax loss.  Several court decisions later and these Wash Sale Losses became disallowed.But you’re a trader!  You may sell and buy, then resell the same trade dozens of times per week, all the while unknowingly accumulating a sizeable Wash Sale Loss disallowance.  Then, when you go to file your taxes, you’re taxed on higher gains than you realized.  Enter the Mark-to-Market election.  No more wash sales!
  • Easier Accounting
    Small family trading entities may have to include a balance sheet with their tax return.  Have you ever tried to reconcile your 1099-B to your trading account balances?  It’s a nightmare.  Because Mark-to-Market reports taxable gains and losses from trading without wash sales and includes end of year open positions, it is much easier to reconcile your trading income to account balances.

Who Can Elect Mark-to-Market?

Mark to Market tax rules, who qualifies and who doesn't.

Before you ask yourself, is “Mark-to-Market” right for you, make sure you’re aware of the strict requirements.  This election is one that the IRS strictly interprets and enforces.

  • Trader or Investor?
    Schedule a Free Tax ConsultationOnly a “dealer in securities” or a “dealer in commodities” may elect Mark-to-Market.  Who is a dealer?  Traders.  But not all traders.  Sec. 475 defines this as “a taxpayer who regularly purchases securities from or sells securities to customers in the ordinary course of a trader or business.”Because many taxpayers asked for further clarification, the IRS later published Topic 429 that defines the factors to qualify as a trader, including seeking to profit from daily market movements, substantial activity, and trading regularly and continuously.  OTA Tax Pros provides the best analysis and explanation of who qualifies as a trader in the Core Tax Strategies class.
  • Trades or Investments?
    In addition to the taxpayer qualifying as a trader, the trades themselves must qualify.  Sec. 475 specifically prohibits “any security held for investment” including “any security which is a hedge” from qualifying for Mark-to-Market.  So, any security you hold long enough to receive dividends, interest or capital appreciation is out.What about options?  Depends.  Options are a gray area since some strategies qualify while others definitely do not.  When does the option expire?  Do you hold to maturity?  Do you own the underlying?  How frequently do you use options?  As with other trading securities, the IRS will require you to keep a record identifying which trades are Mark-to-Market and which are not.
  • Individuals or Entities?
    The truth is both individual and entity-type taxpayers can qualify and elect Mark-to-Market.  Both individuals and entities must make a timely election and file for a change in accounting method.  However, newly formed entities have 75 days from creation to internally elect Mark-to-Market as their initial method of accounting for securities.Perhaps one reason why many taxpayers choose to form a trading business is to fulfill the “identification requirement”.  Individuals must specifically designate by the close of the trading day which trades in which accounts qualify as Mark-to-Market trades, thereby delineating between trades versus investments.  But a trading business can declare that all its securities are trading securities, saving time and burdensome recordkeeping.  For this purpose, it is also recommended that trading businesses not be mixed with other types of investment holding entities or operating businesses.

When to Elect Mark-to-Market?

You may be thinking, “This sounds great – I’ll elect Mark-to-Market right now!”  Hold on.  The election cannot be made retroactively.  If you’re looking at your 1099-B wishing those disallowed Wash Sale Losses would disappear, then you’re too late.  Per Topic 429:

“A trader must make the mark-to-market election by the due date (not including extensions) of the tax return for the year prior to the year for which the election becomes effective.”

There are no exceptions.  Several court cases exist where the IRS clearly demonstrates failure to timely make the election means failure to receive Mark-to-Market treatment.

For the 2017 tax year, you have until April 18, 2017 to make the Mark-to-Market election.

Is Mark-to-Market Right for Me?

Tax advice is not social.  Just because your neighbor elects and exclaims, “Mark-to-Market saved me thousands,” does not mean it’s right for you.Tweet: Tax advice is not social. A decision that's right for your neighbor may not be right for you. https://ctt.ec/5Xc98+  The decision to make the election is multifaceted, and actually making the election is even more complex.

You should seek out a competent tax professional who is well-versed in trader taxation.  They should consider your overall tax situation and ask questions like, “Do you qualify as a trader in securities?” “Do you have any capital loss carryovers?” and “What asset classes do you trade?”

If you’re unsure, we highly recommend attending the Core Tax Strategies class and scheduling a consultation with us at OTA Tax Pros.

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

Join over 170,000 Lessons from the Pros readers. Get new articles delivered to your inbox weekly.