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EDUCATION
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MTM Accounting
The biggest problem for investors and traders occurs when they are unable to deduct trading losses on tax returns, significantly increasing tax bills. Investors are stuck with this problem, but business traders can avoid it by filing timely elections for ordinary tax-loss treatment: Section 475 mark-to-market (MTM) for securities (and futures if elected).
By default, securities and futures investors are stuck with capital-loss treatment, meaning they’re limited to a $3,000 net capital loss against ordinary income. Capital losses first offset capital gains in full without restriction, and after the $3,000 loss limitation against other income of any kind, the rest are carried over to the following tax years.
Business traders have the option to elect Section 475 MTM accounting in a timely fashion. When traders have negative taxable income generated from business losses, MTM accounting turns the losses into unrestricted and unlimited ordinary business losses and net operating losses (NOLs).
Ordinary trading losses can offset all types of income (wages, portfolio income, capital gains, passive income, etc.), whereas capital losses may only offset capital gains. Plus, business expenses and business ordinary trading losses comprise a NOL.
You need to qualify for trader tax status in order to use this election. There are many nuances and misconceptions about Section 475 MTM, and it’s important to learn the rules.
ELECTION PROCEDURES
To elect Section 475 MTM, follow this two-step procedure:
1. File an election statement on time. The MTM election statement is one
simple paragraph; unfortunately the IRS hasn’t created a tax form
for it.
2. Existing taxpayers finish their MTM election by filing a Form 3115
(change of accounting method) with their current-year tax return. A 2011
MTM election filed by April 15, 2011 is reported on a 2011 Form 3115 filed
in 2012 with your 2011 tax returns. New taxpayers adopt Section 475 from
the outset; they aren’t changing their accounting method so they
don’t have to file a Form 3115.
This is an excerpt from Green’s 2012 Trader Tax Guide • Copyright © 2012
