Mark-to-Market Election (Section 475): Complete Guide for Traders

The Section 475 mark-to-market (MTM) election is one of the most significant tax elections available to active traders. It can eliminate wash sale concerns, allow unlimited loss deductions, and simplify your tax reporting. However, it is not right for everyone. This guide explains how MTM works and who should consider it.

What is Mark-to-Market Accounting?

Mark-to-market accounting requires you to treat all securities held at year-end as if they were sold on the last business day of the year at their fair market value. All gains and losses are treated as ordinary income or ordinary losses, not capital gains or losses.

Benefits of the MTM Election

1. No Wash Sale Rule

The biggest benefit for active traders: wash sale rules do not apply to MTM traders. You can buy and sell the same security repeatedly without worrying about disallowed losses.

2. Unlimited Loss Deduction

Capital losses are limited to offsetting capital gains plus $3,000 against ordinary income. MTM losses are ordinary losses with no limitation:

• Capital loss: Maximum $3,000 deduction against ordinary income
• MTM ordinary loss: Fully deductible against all income

3. Simplified Record Keeping

Without wash sale tracking requirements, record keeping becomes much simpler. Every trade is a clean transaction without complex cost basis adjustments.

4. NOL Carryback Potential

Ordinary losses from MTM trading can potentially create Net Operating Losses (NOLs), which may be carried forward to offset future income.

Drawbacks of MTM Election

1. Ordinary Income Treatment

All gains become ordinary income, taxed at rates up to 37%. You lose access to:

• Long-term capital gains rates (0%, 15%, 20%)
• The $3,000 capital loss deduction if you have no gains

2. Year-End Phantom Income

You must recognize gains on positions you still hold at year-end, even if you have not sold:

• Creates potential tax liability without cash
• May need to sell positions to pay taxes
• Stock could decline after year-end but tax is still owed

3. Irrevocable Election

Once you make the MTM election, it is very difficult to revoke. You must request permission from the IRS, which is rarely granted.

4. Requires Trader Tax Status

You must qualify for trader tax status (TTS) to make the MTM election. If the IRS determines you do not qualify for TTS, your MTM election could be invalidated.

How to Make the MTM Election

The election must be made properly and on time:

Deadline

The election must be filed by the due date (not including extensions) of the tax return for the year prior to the year you want MTM to take effect.

How to File

• Internal election statement: Create a statement electing MTM under Section 475(f)
• Attach to tax return: Include with your tax return for the prior year
• File Form 3115: Attach Form 3115 (Application for Change in Accounting Method) to your return for the election year
• New traders: If you are a new trader, you have until 2 months and 15 days after starting trading

Securities vs. Commodities Election

Section 475 allows separate elections for securities and commodities:

• Section 475(f)(1): Securities (stocks, options on stocks, bonds)
• Section 475(f)(2): Commodities (futures, options on futures, forex)

You can elect one, both, or neither. Many traders elect MTM for securities only, keeping Section 1256 treatment for futures and index options.

Who Should Consider MTM?

MTM is most beneficial for:

• Active day traders: Who rarely hold positions long-term
• Traders with significant wash sales: Who lose large deductions to wash sale rules
• Traders with volatile results: Who may have large loss years
• Those in lower tax brackets: Where the ordinary income treatment matters less

Who Should Avoid MTM?

MTM may not be right for:

• Long-term investors: Who benefit from LTCG rates
• Consistently profitable traders: Who would pay more at ordinary rates
• High-income earners: Already in the top tax brackets
• Those who hold positions over year-end: Who do not want phantom income

MTM and Business Entities

If you trade through an entity (LLC, partnership, S-corp), the MTM election is made at the entity level. Consider:

• Entity must qualify for TTS
• Election binds all members/shareholders
• May want separate entities for different strategies

Year-End Planning with MTM

With MTM, year-end planning is different:

• No loss harvesting needed: Wash sales do not apply
• Consider closing winners: No benefit to deferring gains
• Manage year-end positions: Decide if you want phantom gains/losses
• Estimated taxes: Plan for potential phantom income

Revoking the MTM Election

Revoking is difficult but not impossible:

• Must request IRS permission
• File Form 3115 for automatic consent (if eligible)
• Permission is granted sparingly
• Generally need to show change in circumstances

Summary

The Section 475 mark-to-market election provides significant benefits for active traders, primarily eliminating wash sale concerns and allowing unlimited ordinary loss deductions. However, it converts all gains to ordinary income and creates potential phantom income on year-end holdings. The election is essentially permanent and requires trader tax status. Carefully analyze your trading pattern and tax situation before making this important election.

Learn more about related topics in our guides on trader tax status qualification and the wash sale rule.