How Mark-To-Market Accounting Election Affects You

What is Mark to Market (MTM)? A simple explanation would be that MTM is an accounting method that describes how a trader calculates their trading gains and losses, and how these gains and losses are reported on a trader’s annual income tax return. MTM refers to a year-end process where you mark all your open positions to market prices. Essentially, you are calculating the sale of all open positions at year-end using the closing price of the last day of trading in that year.

By default, securities and Section 1256 investors (Futures & Commodities) are stuck with capital-loss treatment, meaning they’re limited to a $3,000 net capital loss against ordinary income. The losses first offset capital gains in full without restriction. After the $3,000 loss limitation against other income is applied, the rest is carried over to the following tax years. This hurts traders’ ability to trade as their capital account is dwindled.  It can take years or even a lifetime to use up their capital loss carryovers. 

Only those who qualify as a trader in securities status could elect MTM to report their trading gains and losses. Those who qualify as investors are disqualified from electing MTM.

The IRC section 475 MTM basically allows traders to convert gains and losses from the capital gain treatment to ordinary income loss treatment. The MTM essentially cancels the need to report wash sale adjustments and allows a trader to claim any amount of loss in the year it occurred. Individual traders must make the election by April 15 for the current year. Failure to file the election by the deadline will cause the trader the ability to claim losses as ordinary and they will be stuck with capital loss carryovers.

Nuances & Misconceptions. There are many nuances and misconceptions about Section 475 MTM. For example, you’re entitled to have segregate investment positions that aren’t subject to Section 475 MTM treatment, meaning at year-end, you can defer unrealized gains on properly segregated investments. You can have both ordinary tax losses on business trading and deferral with lower long-term capital gains tax rates on segregated investment positions.