Section 475 MTM Accounting
Section 475 MTM exempts traders from capital loss and wash sale loss limitations.
The biggest problem for investors and traders occurs when they’re unable to deduct trading losses on tax returns, significantly increasing tax bills or missing opportunities for tax refunds.
Elect out of capital loss limitations and wash sale losses
By default, investors have an annual $3,000 capital loss limitation against other income and wash sale loss deferrals on securities. Investors have no choice, but business traders qualifying for trader tax status (TTS) can avoid it by filing timely elections for business ordinary tax-loss treatment: Section 475 mark-to-market (MTM) for securities and/or Section 1256 contracts if elected. (We recommend a Section 475 election for securities only, so futures traders retain lower 60/40 capital gains rates on Section 1256 contracts.)
Section 475 trades are ordinary gain or loss, not capital gain and loss. Section 475 ordinary losses are unlimited business losses, offsetting all types of income, and they contribute to net operating losses (NOLs), which often generate immediate tax relief. Section 475 trades are also exempt from wash sale loss treatment. (Read wash sale losses in our Trader Tax Center.)
Section 475 election procedures
Existing taxpayer individuals and partnerships that qualify for TTS and want Section 475 must file a 2016 Section 475 election statement with their 2015 tax return or extension by April 18, 2016. Existing S-Corps file in the same manner by March 15, 2016. The MTM election statement is one simple paragraph; unfortunately, the IRS hasn’t created a tax form for it. (See our suggested wording in Green’s 2016 Trader Tax Guide.) Don’t forget an important second step: Existing taxpayers complete the election process by filing a Form 3115 (change of accounting method) with the election-year tax return. A 2015 MTM election filed by April 15, 2015, is reported and perfected on a 2015 Form 3115 filed with your 2015 tax returns in 2016 – by the due date of the return including extensions.
A new entity (new taxpayer) can deliver Section 475 MTM for the rest of the current tax year on trading losses generated in the entity account if the entity files an internal Section 475 MTM election (resolution) within 75 days of inception. A new entity does not have to file a Form 3115 since it’s adopting Section 475 from beginning, rather than changing its accounting method.
Segregated investment positions
Traders can have it all: Section 475 business ordinary loss treatment on active securities trading, lower 60/40 capital gains rates on Section 1256 contracts and the realization (cash) method on segregated investment positions. On duly segregated investments, Section 475 traders don’t give up tax deferral and lower long-term capital gains rates.
For more in-depth information about Section 475 MTM, including many nuances to consider in making or revoking an election, climbing out of a capital loss carryover hole, and much more, read Green’s 2016 Trader Tax Guide.