Financial Services Alert: The 475(f) Mark-to-Market Election For Traders Can Yield Significant Advantages
3/11/2010
Many taxpayers may be unaware of Internal Revenue Code Section 475(f), a provision that gives fund managers and other securities traders the opportunity to mark to market stocks or other securities. According to the mark-to-market method of accounting, any security held by an electing trader is treated as sold for its fair market value (FMV) on the last day of the year. The result is that the taxpayer includes in gross income any gains or losses on securities including any unrealized gains or losses that exist at the end of the year.
Generally, realized short-term capital gains and losses are taxed at ordinary rates. One of the most significant benefits of a 475(f) election is that traders who incur losses can use them to offset other taxable income without restrictions that apply to capital losses. Section 475(f) essentially changes the character of income from capital to ordinary. Without this election, deductible losses for individual taxpayers would be limited to capital gains plus an additional $3,000 with the balance available to be carried forward. If the election is made, losses will be considered business losses that can add to or create a net operating loss that can be carried back two years and forward 20 years. Another key advantage is that in most situations, taxable income and book income become equal under 475(f), eliminating book/tax differences that may arise (i.e. constructive sales, wash sales, and straddles).
It is important to note that once the election is made, it cannot be revoked unless a formal request is made to the IRS by filing Form 3115.
Who is Eligible to Make the 475(f) Election?
The ability to treat incurred losses as ordinary is only available to taxpayers who are “traders” that timely make the 475(f) election. It is not available to traditional investors. At the heart of the matter is what constitutes an eligible or qualified trader. The 475(f) provision is meant to apply to traders of stocks and other securities; the method, however, by which the IRS distinguishes between a trader and an investor is not crystal clear. This has resulted in uncertainty—as well as frequent court challenges—as to whether a particular taxpayer (i.e., “trader”) can take this potentially beneficial election.
For more information on this and related issues, please contact Warren Abkowitz, CPA, J.H. Cohn tax partner, or your J.H. Cohn engagement partner, at 877-704-3500.
Warren Abkowitz, CPA, is a J.H. Cohn tax partner and a member of the Firm's Financial Services Group. He can be reached via email or at 973-618-6269.
March 2010
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