Tax Summary of the Mark-to-Market elections

Tax Summary of the §475(f)(1) election for Securities:

forgo making the election and…

  • Securities trading losses are limited for deductibility if §475 M2M is not elected. (Typically limited to $3,000 in the current year with the excess being carried forward to future years) 🙁
  • Starting in 2021 securities trading losses can be limited for deductibility if §475 M2M is elected. (Typically limited to $262,000, or $524,000 if married filing jointly, in the current year with the excess being carried forward to future years) 🙁
  • Securities are limited for deductibility of any trading losses if §475 M2M is not elected. 🙁
  • Securities are subject to the Wash Sale Rule if §475 M2M is not elected. 🙁
  • Paper losses in securities held at year-end are not deductible if §475 M2M is not elected. 🙁
  • Paper gains in securities held at year-end are not taxable if §475 M2M is not elected. 🙂
  • Gains in securities held over 12 months are taxed at long-term tax rates if §475 M2M is not elected. 🙂
  • Substitute payment <46-day rule for short sales may cause certain short dividends to be not deductible if §475 M2M is not elected. 🙁

 

make the election and…

  • Securities trading losses might not be limited for deductibility of any trading losses if §475 M2M is elected. 🙂
  • But starting in 2021, securities trading losses can be limited for deductibility to $262,000, or $524,000 if married filing jointly, in the current year with the excess being carried forward to future years) 🙁
  • Securities are not subject to the Wash Sale Rule if §475 M2M is elected. 🙂
  • Paper losses in securities held at year-end are deductible if §475 M2M is elected. 🙂
  • Paper gains in securities held at year-end are taxable if §475 M2M is elected. 🙁
  • Gains in securities held over 12 months are not taxed at long-term tax rates if §475 M2M is elected. 🙁
  • Substitute payment <46-day rule for short sales generally has no effect if §475 M2M is elected. 🙂
  • Old Capital Loss Carry-forwards may be trapped on Schedule D if §475 M2M is elected. 🙁

 

Tax Summary of the §475(f)(2) election for Futures/Commodities/§1256Contracts:

forgo making the election and…

  • §1256 contracts have a nice long-term gain rate for 60% of gains if §475 M2M is not elected. 🙂
  • §1256 contracts are limited for deductibility of any trading losses if §475 M2M is not elected. 🙁

 

make the election and…

  • §1256 contracts have no long-term gain rate for 60% of gains if §475 M2M is elected. 🙁
  • §1256 contracts might not be limited for deductibility of any trading losses if §475 M2M is elected. 🙂
  • But starting in 2021, securities trading losses can be limited for deductibility to $262,000, or $524,000 if married filing jointly, in the current year with the excess being carried forward to future years) 🙁
  • Old Capital Loss Carry-forwards may be trapped on Schedule D if §475 M2M is elected. 🙁

 

Trade both Securities and Futures/Commodities/§1256Contracts and you have a dilemma:
If you are guaranteed to be profitable in Futures/Commodities/§1256Contracts then the choice often is simple: Do not elect §475 M2M for Futures/Commodities/§1256Contracts. You will be taxed at the favorable 60/40 tax rates. 🙂

The problem, the needed compromise, comes if there is a possibility that you might have a year with a loss in Futures/Commodities/§1256Contracts.

Example: consider making $400,000 in securities gains with §475 M2M and then losing $400,000 in futures with no §475 M2M – a potential disaster waiting to happen – $400,000 being taxed at your top income tax rate, and no current year deduction for $397,000 of the capital losses.

Avoid this possibility (and allow the $400,000 gain to be fully offset with the $400,000 loss) by electing §475 M2M now for Futures/Commodities/§1256Contracts – but then you would give up the special 60/40 taxation benefit that you would enjoy if you do not elect. 🙁

 

Trade (PTP) Publicly Traded Partnership securities and you can step into a vicious tax trap:

Most PTP do not elect M2M, therefore you may receive a Schedule K-1 with short-term or long-term capital losses or losses from §1256 Futures contracts. Unless you happen to have capital gains to offset these types of losses, you may be limited to deducting no more than $3,000 per year. 🙁

Remember that if you have elected M2M for your own Securities trading and/or your own §1256 Futures contracts trading that the gains from those are ordinary gain, and therefore may not be offset against capital losses passed through the PTP. Further, the PTP pass-through losses will reduce your tax basis in the security position held, resulting in an even larger taxable ordinary gain or a smaller tax-deductible ordinary loss. 🙁

 

Invest in hedge funds and pass-through entities, or have managed accounts and you may have a similar issue as with PTPs:

Many hedge funds, and other pass-through entities may have capital gains/losses rather than ordinary gains/losses reported on their Schedule K-1s. Likewise most managed accounts have capital gains/losses rather than ordinary. If the net of all your trading and investing result in large capital losses after applying the wash sales rule, you may be limited to deducting no more than $3,000 per year. 🙁

 

Trading in Forex (which has its own tax elections for ordinary/capital tax treatment) and also trading Securities, Publicly Traded Partnership (PTP) securities and/or Futures/Commodities/§1256Contracts and you can really have a dilemma with very unfortunate income tax consequences:

Each of these four classifications of trading will result in gains and losses. If the year ends with a net of capital losses, you may be limited to deducting a maximum of $3,000. Any ordinary gains will then be taxed without the benefit of being offset by the year’s capital losses in excess of that $3,000 amount. 🙁

 

Possible saving grace: a note on Limited Deductibility of trading losses if §475 is not made:

This can vary depending on the taxpayer, but generally for individuals Securities Losses may be offset against Capital Gains each year and if losses are greater, then an additional $3,000 is generally used to offset other income each year. Any remaining is used as a capital loss carry-forward year-to-year.

For Futures/Commodities/§1256Contracts the rules are similar to the above, but there is an optional election that can be made to carryback a portion of the year’s loss three years to offset other Futures/Commodities/§1256Contracts gains that were taxed under the 60/40 tax rate. 🙂