Capital Gains Trader
By “default,” traders are usually taxed under the oftentimes undesirable §1221 capital gains method (realization method) of accounting, just the same as most other taxpayers.
But taxpayer businesses that maintain a complete and separable set of accounting books and records which qualify under IRS Regs. §1.446-1(d)(1) and that otherwise qualify to file with Trader Status may optionally elect in advance(*1), by filing with the IRS, to use the “Mark-to-Market” (M2M) method of accounting, pursuant to IRC §475(f), for the election year and all ensuing years, as described here. This accounting method treats what would normally be Schedule D “capital gains and losses” as Form 4797 “ordinary gains and losses.”
When you have a capital loss the procedure for netting capital gains and losses generally works as follows:
- Net all of your §1256 gains and losses for the year (generally these are your Commodities or Futures trades).
- Split the amount from #1 with 40% going to short-term capital gains or losses and the remaining 60% to long-term.
- Combine and net the above short-term gains and losses with all of your other short-term gains and losses (including any short-term loss carry forward amount from the previous year).
- Combine and net the above long-term gains and losses with all of your other long-term gains and losses (including any long-term loss carry forward amount from the previous year).
- If either #3 and/or #4 shows a net loss, then combine and net the resulting short-term amount against the long-term amount.
- If the result of #5 is an overall loss then you should deduct up to $3,000 of the loss against ordinary income per year.
- Carry over any remaining losses in excess of the $3,000 to future tax years (also carry over any portion of the amount from #6 that was not utilized because you had a negative AGI).
Optional §1256 contracts net loss carryback election:
Using IRS Form 6781 a taxpayer may elect to carry back three years an amount of net, net §1256 capital losses in excess of $3,000 from §1256 contracts. The carried back losses may generate a tax refund by being offset against §1256 contract gains in that 3rd year, with any remaining net, net §1256 capital loss coming forward year-by-year.
(*1) Generally, individuals elect to use the mark-to-market method of accounting by filing the election statement no later than April 15th for the year of the election (i.e. after the beginning and before April 16th of the year for which M2M takes effect). For most partnerships, LLCs and corporations that means no later than March 15th (or April 15th as the case may be) for the year of the election. For new taxpayers, for example those who have not previously filed an income tax return (such as a newly formed multi-member LLC), then that means #1 preparing the actual election statement no later than 2 months and 15 days after the entity’s formation and #2 to notify the IRS that the election was timely made, the new taxpayer must attach a copy of the statement to its original federal income tax return for the election year (which is filed after the end of the first year).
The §475(f) election may be revoked by filing a request to change the method of accounting no later than April 15th for the year of the revocation (or other date similar as described above) – or in lieu of revocation the owners may simply stop using the entity, liquidate it or dissolve it.
In addition, generally, IRS form 3115 must be timely filed one year after the request to change is filed: either the request to change to M2M or a request to revoke a prior M2M election.
Late M2M elections are generally not allowed:
Pursuant to Reg. §301.9100-2(b) This paragraph (b) does not apply to regulatory or statutory elections that must be made by the due date of the return excluding extensions.