tradertaxcpa No Comments

Mark To Market Accounting

Think of this as a Trader Tax Loss Insurance Plan!

You can only claim Mark To Market Accounting IF you qualify for trader status.  Not sure if you qualify for trader status? Refer to this post.

One of the biggest advantages of claiming trader tax status is the ability to elect mark to market accounting (IRC Section 475). The Mark to Market method has the effect of converting capital gains and losses into ordinary gains and losses.  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 Accounting

  • 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

  • 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.

How to make 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 2021, you will enclose an election statement with your 2020 tax return by April 15, 2021.

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 2021 tax year, you’ll fill out and send in Form 3115 with your 2021 tax return by the April 15, 2022 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.

Consult Us

Does the Mark To Market election make sense for you?  Have you accumulated capital losses over your trading career and finally reached your “break-through” year to where you have achieved profitability?  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.  If you need help schedule a 30 minute consultation to help determine if Mark to Market accounting is right for your trading business.

tradertaxcpa No Comments

Wash Sales

Wash Sale Rules Defined

Generally speaking, the Wash Sale Rule is an IRS rule that prohibits a taxpayer from claiming a loss on the sale or trade of a security in a wash sale.  Said another way this rule defines a wash sale as one that occurs when an individual sells or trades a security at a loss, and within 30 days before or after this sale, buys a “substantially identical” stock or security, or acquires a contract or option to do so.  A wash sale also results if an individual sells a security, and the spouse or a company controlled by the individuals buys a substantially equivalent security. The Wash sale rule applies to traders the same way it applies to investors.  The difference is that traders have a much harder time keeping records relating to wash sales because they engage in so hundreds of transactions. This rule does not apply to gains, but only to losses.   Naturally, the IRS prefers to tax all of your gains!

HOW TO AVOID WASH SALES

If you make hundreds or thousands of trades each year, the record keeping required for compliance with the wash sale rule can be nearly impossible. There are several ways to eliminate the problem for active traders. The first way to avoid the wash sale rule is to simply wait for 31 days after you sold the stock or option before you buy it back. The second way is to elect the mark-to- market accounting method. To make the election a trader must qualify for trader tax status.  In general, 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. You can make the election by attaching a statement either to your income tax return or to a request for an extension of time to file your return. The statement should include the following information:

 That you’re making an election under section 475(f);

 The first tax year for which the election is effective; and

 The trade or business for which you’re making the election

There are some other important things you should know if you’re thinking of making this election:

 All of your trading gains and losses will be treated as ordinary income; there will be no capital gains treatment. If a trader is carrying a capital loss, they cannot be used to offset ordinary gains (capital losses only offset capital losses)

 Any stock or security you hold at the end of the year is marked to market. This means you report gain or loss as if you sold it at the close of business on the last trading day of the year for its fair market value.

 Once you make this election you’re stuck with it. You can revoke it only with the consent of the IRS.

Be careful when electing 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 for that year. Please consult a CPA, Lawyer, or tax professional if you are considering making the election. If you use our tax preparation and planning services and not currently using mark to market accounting we can help sort your trades across all brokerage accounts to identify wash sales.

ADDITIONAL RULES ABOUT WASH SALES

Below are several different items you need to consider when you deal with the wash sale rules:

 If you bought identical shares within the previous 30 days that
aren’t replacement shares, it is not a wash sale.

 There are mechanical rules to handle the situation where you don’t buy exactly the same number of shares you sold, or where you bought and sold multiple lots of shares.

 Your loss may be disallowed if a person who’s related to you (or an entity related to you such as an IRA) buys replacement property.

 During the wash sale period, if you enter into a contract or option to acquire replacement stock, that will be considered a wash sale.

 If you don’t sell the replacement stock in the same year, your loss will be postponed, possibly to a year when the deduction is of far less value.

 If you die before selling the replacement stock, neither you nor your heirs will benefit from the basis adjustment.

 You can also lose the benefit of the deduction permanently if you sell stock and arrange to have a related person – or your IRA – buy replacement stock.