Overview
The Section 475(f) election allows qualifying traders to elect "mark-to-market" accounting for their trading activities. This election converts capital gains and losses to ordinary income/loss, providing significant tax advantages for active traders.
This election is particularly valuable for algo traders and frequent traders who may have substantial trading losses in some years.
✓ Key Benefit
Without the 475(f) election, capital losses are limited to $3,000 per year deduction against ordinary income. With the election, trading losses are fully deductible against all income with no limit.
Key Benefits
💰 Unlimited Loss Deduction
Deduct full trading losses against ordinary income - no $3,000 annual cap
🔄 No Wash Sale Rules
Wash sale disallowance doesn't apply to mark-to-market securities
📈 Business Expense Deductions
Deduct trading expenses on Schedule C (data feeds, software, education)
📅 Simplified Record Keeping
No need to track wash sales or holding periods for TTS securities
Trader Tax Status Qualification
Before you can make the 475(f) election, you must first qualify for Trader Tax Status (TTS). The IRS looks at several factors:
Required Elements
- Substantial trading activity - Trade frequently (typically 4+ trades per day on most trading days)
- Seek to profit from short-term price swings - Not long-term investing
- Trading must be "substantial" - Both in time and activity level
- Continuous activity - Trade on a regular, ongoing basis throughout the year
IRS Factors
| Factor | Favorable | Unfavorable |
|---|---|---|
| Trade Frequency | Multiple trades daily | Few trades per week |
| Holding Period | Intraday to days | Weeks to months |
| Time Spent | 30+ hours/week | Part-time |
| Income Source | Primary income | Side activity |
| Intent | Short-term profits | Long-term appreciation |
⚠ No Bright-Line Test
The IRS doesn't provide a specific number of trades required. Courts have denied TTS to taxpayers with hundreds of annual trades, while approving others with fewer. The totality of circumstances matters.
How Mark-to-Market Works
Under mark-to-market accounting, you're deemed to sell all securities at fair market value on the last business day of the tax year, and immediately repurchase them at the same price.
Practical Effect
- All gains and losses become ordinary - No capital gain rates (good or bad)
- Unrealized gains are taxed - You pay tax on paper profits
- Losses are fully deductible - Against all types of income
- New cost basis - Positions start each year at year-end FMV
Example
| Scenario | Without 475(f) | With 475(f) |
|---|---|---|
| Trading Loss: $50,000 | Deduct $3,000; carry forward $47,000 | Deduct full $50,000 |
| W-2 Income: $150,000 | Taxable: $147,000 | Taxable: $100,000 |
| Approx. Tax Savings | $0 | ~$16,000 |
Making the Election
📅 Critical Deadline
The 475(f) election must be made by the due date (without extensions) of the tax return for the year prior to the year you want the election to take effect. For 2025, you must elect by April 15, 2025 (for it to apply to 2025 trading).
Election Procedure
- Attach a statement to your timely-filed tax return (or extension request)
- Statement must include:
- Your name and identifying number
- Statement that you are making an election under Section 475(f)(1) for securities (and/or 475(f)(2) for commodities)
- The first tax year for which the election is effective
- The trade or business for which you're making the election
- Maintain documentation supporting your trader tax status
Sample Election Statement
Taxpayer: [Your Name]
SSN: XXX-XX-XXXX
The taxpayer hereby elects to use the mark-to-market method of accounting under IRC Section 475(f)(1) for securities. This election is effective for the tax year beginning January 1, [Year]. The taxpayer is engaged in the trade or business of trading securities.
Potential Downsides
- No long-term capital gains rates - All gains are ordinary income (up to 37% vs. 20%)
- Unrealized gains are taxed - Pay tax on paper profits at year-end
- Difficult to revoke - IRS permission required to revoke
- Self-employment tax may apply - If trading through a business entity
- Must segregate investment positions - Election doesn't apply to separately identified investments
Next Steps
- Use the 475(f) Calculator to estimate your potential savings
- Document your trading activity - trades per day, time spent, holding periods
- Consult a tax professional - TTS and 475(f) are audit-sensitive areas
- Make the election timely - before April 15 for the following year