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Mark To Market Accounting

One of the biggest advantages of claiming trader status is the ability to elect mark to market accounting (Internal Revenue Code Section 475). The Mark to Market method has the effect of converting capital gains and losses into ordinary gains and losses. You'll make this adjustment at the end of the year. All open positions are priced as if they were sold on the last trading day of the year (marked to market) and then "bought back" at the same price on the 1st trading day in January. Your unrealized gain or loss is then recorded for tax purposes on Form 4797

Advantages of Mark to Market 

Some of the advantages of electing mark to market accounting for your trading business are:

  • No Wash Sales: Traders using mark to market accounting are exempt from the wash sale rule
  • Losses are FULLY deductible: this is the biggest reason to make the mark to market election. Losses are converted into ordinary losses (not capital losses), so you are not restricted by the $3000 capital loss limitation. This allows a trader to deduct all losses in the year that they occur, provided there is other income to off set it. You can even carry back the losses to previous tax years!
  • No change to self-employment tax exemption

Disadvantages of Mark to Market

There are some disadvantages to electing mark to market accounting for your trading business. Most notably:

  • No Capital Loss Carryover: if a trader is carrying capital losses, electing mark to market will change the classification of the trading gains going forward. Gains will be ordinary gains and any capital losses cannot be used to offset those gains (capital losses only offset capital gains). 
  • Election is permanent: Once you make the election, you have to continue to use the mark to market method for all future years. You can change the election ONLY with the consent of the IRS (good luck), and they generally won't grant this consent if your reason for changing is simply that the election didn't turn out to your advantage. 
Making the Mark to Market Election

In order to make the mark to market election, a trader must enclose a statement of intent with the prior year's tax return (or extension request) by April 15. For example, if you intend to switch to the mark to market method for 2013, you will enclose an election statement with your 2012 tax return by April 15. 

Then you'll need to fill out and send in Form 3115 (Change of Accounting Methods) with your tax return for the following year. For instance, if you elect mark to market for the 2013 tax year, you'll fill out and send in Form 3115 with your 2013 tax return by the April 15, 2014 due date.

If you have any open positions on January 1 of the year you make the election, you'll also need to calculate and report Section 481(a) adjustments on Form 3115. This "marks to market" any open positions you have at the time you make the switch. Any unrealized gains over $25,000 can be prorated over 4 years and any unrealized losses can be taken in full on the current year's tax return.

Be careful when making the election to the mark to market method. If you make any mistakes or miss any deadlines on sending in the right forms, you will lose out on the mark to market tax benefits.

If you miss the mark to market deadline, you can file for an extension of up to six months to make your mark to market election via a private letter ruling procedure under IRS Section 301.9100-1 (Extensions of Time to Make Elections). Warning: you may get charged by the IRS to do this.

Don't Go It Alone

Does the mark to market method make sense for you? No two traders are the same and there isn't a one size fits all approach to making this election. Shrink My Taxes is here to help. We offer a free 30 minute consultation to help you determine if mark to market is right for your trading business. Fill out our Trader Evaluation and e-mail us at info@shrinkmytaxes.com to get started. If you retain Shrink My Taxes to do your tax preparation, we'll even fill out and file the appropriate mark to market election forms at no additional cost!

 


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