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Section 475(f) Mark-to-Market Election

📅 Updated December 2025 ⏱ 25 min read 💰 Tax Strategy

Mark-to-Market Accounting Overview

The Section 475(f) election allows qualifying traders to elect "mark-to-market" (MTM) accounting for their trading activities. This fundamental change in tax treatment converts capital gains and losses to ordinary income and loss, providing significant tax planning opportunities for active traders.

Originally designed for securities dealers, IRC Section 475(f) was extended to traders in 1997, recognizing that certain active trading patterns more closely resemble a business than passive investment.

What is Mark-to-Market Accounting?

Under MTM accounting, you are 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. This creates a "constructive sale" that realizes all gains and losses annually, whether or not positions are actually closed.

How MTM Works in Practice

Qualifying as Trader vs Investor

Before making the 475(f) election, you must first establish Trader Tax Status (TTS). The IRS distinguishes between traders and investors based on facts and circumstances, not a bright-line test.

Trader Tax Status Requirements

The seminal case Higgins v. Commissioner (312 U.S. 212) established that trading must constitute a "trade or business" to qualify for trader treatment. Courts and the IRS examine:

Factor Trader (Favorable) Investor (Unfavorable)
Frequency Daily trading; multiple trades per day Occasional or periodic trades
Volume Hundreds to thousands of annual trades Dozens of trades or fewer
Holding Period Intraday to several days (short-term) Weeks, months, or years
Time Commitment Substantial time (4+ hours daily) Part-time or sporadic
Intent Profit from short-term price fluctuations Long-term appreciation, dividends, interest
Income Source Trading is primary income Trading supplements other income
Record Keeping Detailed trading logs, systems Basic brokerage statements

No Safe Harbor Test

The IRS has never published specific numerical thresholds. Courts have denied TTS to taxpayers with 300+ annual trades while approving others with fewer trades. The totality of circumstances matters—no single factor is determinative.

Trader Qualification Test

Use this self-assessment to evaluate your TTS likelihood:

Question Your Answer Points
Do you make 4+ round-trip trades per day on most trading days? Yes / No +3 / 0
Are your average holding periods under 31 days? Yes / No +2 / 0
Do you spend 30+ hours per week on trading activities? Yes / No +3 / 0
Do you execute 500+ trades annually? Yes / No +2 / 0
Is trading your primary source of income? Yes / No +2 / 0
Do you maintain contemporaneous trading records/logs? Yes / No +1 / 0
Do you have a dedicated trading office/workspace? Yes / No +1 / 0
Do you subscribe to professional trading tools/data? Yes / No +1 / 0

Scoring:

Key Court Cases

Election Procedures & Deadlines

The 475(f) election is governed by strict procedural and timing requirements. Missing the deadline or failing to properly document the election can invalidate it entirely.

Critical Deadline

Timing is Mandatory

The election must be made by the due date of the tax return (without extensions) for the year prior to the first year you want the election to take effect.

Example: To elect MTM for tax year 2025, you must file the election statement by April 15, 2025 (the unextended due date of your 2024 return).

Election Statement Requirements

The election statement must include:

  1. Taxpayer's name and identifying number (SSN or EIN)
  2. Explicit statement electing Section 475(f) treatment
  3. Specification of which instruments (securities and/or commodities)
  4. First tax year for which election is effective
  5. Description of the trade or business

How to Make the Election

Sample Election Statement

SECTION 475(f) ELECTION STATEMENT Taxpayer Name: [Your Full Legal Name] Taxpayer Identification Number: [SSN or EIN] Pursuant to Internal Revenue Code Section 475(f)(1), the taxpayer hereby elects to use the mark-to-market method of accounting for securities. This election is effective beginning with the tax year commencing January 1, [Year]. The taxpayer is engaged in the trade or business of trading securities as a trader (not a dealer). The taxpayer meets the requirements for trader tax status as defined by applicable case law and IRS guidance. Date: [Date] Signature: ___________________

For Commodities

If you also trade futures, forex, or other commodities, make a separate 475(f)(2) election:

Pursuant to Internal Revenue Code Section 475(f)(2), the taxpayer hereby elects to use the mark-to-market method of accounting for commodities.

First-Year vs Subsequent Elections

First-Year Election (New Traders)

If this is your first year engaged in the trading business, you can make the election by the unextended due date of your first return for the year you began trading.

Example: You start trading in March 2025. You can elect 475(f) for 2025 by filing the election with your 2025 return (due April 15, 2026).

First-Year Advantage

New traders have more flexibility. You can evaluate your first year's results before deciding whether to make the election on your return for that year.

Subsequent-Year Elections (Existing Traders)

For taxpayers already trading in prior years, the election must be made in the prior year—creating a prospective election only.

Example Timeline:

Special Timing Considerations

Advantages

1. Ordinary Loss Treatment (Unlimited Deduction)

The most powerful benefit: trading losses become ordinary losses, fully deductible against all income with no limitation.

Without 475(f) Election

  • Capital losses limited to capital gains + $3,000
  • Excess losses carried forward indefinitely
  • May never fully utilize losses

With 475(f) Election

  • Ordinary losses offset all income (wages, business, etc.)
  • Full current-year deduction (subject to overall limitations)
  • Immediate tax benefit

Example:

Income/Loss Without 475(f) With 475(f)
W-2 Wages $200,000 $200,000
Trading Loss ($75,000) ($75,000)
Current Deduction ($3,000) ($75,000)
Carryforward ($72,000) $0
Taxable Income $197,000 $125,000
Approx. Tax Savings $0 ~$25,000

2. No Wash Sale Rules

IRC Section 1091 (wash sale rule) does NOT apply to dealers or traders using mark-to-market accounting. This is transformational for active traders.

Wash Sale Freedom

Without 475(f), selling a security at a loss and repurchasing within 30 days disallows the loss. High-frequency traders can accumulate massive wash sale disallowances, inflating taxable income despite actual losses.

With 475(f), wash sales simply don't apply. Trade the same security repeatedly without loss disallowance.

Example: Day trader buys/sells AAPL 200 times in a year.

3. Business Expense Deductions

Trading becomes a business activity, allowing Schedule C deductions for:

These expenses are deductible "above the line" (reducing AGI), unlike miscellaneous itemized deductions which were eliminated by TCJA.

4. Simplified Recordkeeping

5. Net Operating Losses (NOLs)

Large trading losses can create NOLs that can be:

Disadvantages

1. No Long-Term Capital Gains Rates

All gains become ordinary income taxed at rates up to 37% (federal) instead of the preferential long-term capital gains rate of 20% (plus 3.8% net investment income tax).

Tax Rate Penalty for Winners

If you have consistent trading profits, the 475(f) election can increase your tax liability significantly. For a $500,000 trading gain, the difference could exceed $85,000 in additional federal tax.

Example:

Scenario $100,000 Gain Tax Rate Federal Tax
Long-Term Capital Gain (No 475f) $100,000 20% + 3.8% $23,800
Ordinary Income (With 475f) $100,000 37% $37,000
Additional Tax $13,200

2. Unrealized Gains Are Taxed

Year-end open positions are marked to market, creating taxable income even if you haven't sold. This can create cash flow problems.

Example: On December 31, you hold $200,000 of stock with $50,000 unrealized gain. Under MTM, you owe tax on the $50,000 gain (~$18,500 at 37%) despite not selling. If the stock declines in January, you still owe the tax for the prior year.

3. Difficult to Revoke

Once made, the 475(f) election can only be revoked with IRS consent via Form 3115 (change in accounting method). The IRS rarely grants consent absent a material change in business circumstances.

Permanent Election (Effectively)

Treat the 475(f) election as permanent. You cannot strategically elect in loss years and revoke in profitable years.

4. Potential Self-Employment Tax

Whether MTM trading income is subject to self-employment tax (15.3% on first ~$168,600 in 2024) is unsettled:

5. Must Segregate Investment Positions

If you want to preserve capital gains treatment for long-term investments, you must identify them in writing before the close of the day acquired. These identified securities are excluded from MTM treatment.

Failure to properly identify means ALL securities are subject to MTM—converting even your long-term retirement holdings to ordinary income.

Entity Selection Impact

The entity through which you trade significantly affects the 475(f) election's tax impact.

Individual (Sole Proprietorship)

Pros:

Cons:

Single-Member LLC (Disregarded Entity)

Pros:

Cons:

Partnership / Multi-Member LLC

Pros:

Cons:

S Corporation

Pros:

Cons:

S-Corp Strategy for Traders

Many full-time traders use S-corps to pay themselves a modest salary (~$50,000-$80,000) subject to SE tax, then take additional profits as distributions (no SE tax). However, the salary must be "reasonable" for the services performed.

C Corporation

Pros:

Cons:

Recommendation: Most active traders elect 475(f) through an S-corporation or as an individual. Partnerships work for trading groups. C-corps are generally disfavored.

Partial Elections (Identified Positions)

You can exclude certain securities from MTM treatment by identifying them as investments held for long-term appreciation (not trading).

Identification Requirements

Pursuant to IRC § 475(f)(1)(B) and Treas. Reg. § 1.475(f)-1(d), identified securities must be:

  1. Identified in writing in your books and records
  2. Identified by the close of the day acquired (not end of year)
  3. Clearly marked as "investment" or "excluded from MTM"
  4. Held separately from trading positions (e.g., different brokerage account)

What Can Be Identified

What Cannot Be Identified

Sample Identification Record

IDENTIFIED SECURITIES - EXCLUDED FROM MTM TREATMENT Date: [Acquisition Date] Security: [Description, CUSIP/Ticker] Quantity: [Shares/Units] Purchase Price: [Cost Basis] Account: [Account Number] This security is identified as held for investment purposes and is excluded from mark-to-market accounting under IRC § 475(f)(1)(B). It is not held in connection with activities as a securities trader. Notation made contemporaneously on acquisition date.

Strict Compliance Required

Failure to properly identify on the acquisition date permanently subjects that security to MTM treatment. Year-end identification is too late and will be disregarded by the IRS.

Revocation Rules

Revoking the 475(f) election requires IRS consent via a change in accounting method (Form 3115).

Automatic Consent (Rare)

The IRS will automatically grant consent if:

Non-Automatic Consent (IRS Discretion)

For all other situations, you must request permission. The IRS considers:

Common denial reasons:

Form 3115 Procedure

  1. File Form 3115 (Application for Change in Accounting Method)
  2. Attach to timely-filed return for the year of change
  3. File copy with IRS National Office (separate submission)
  4. Calculate Section 481(a) adjustment (cumulative adjustment for change)
  5. Wait for IRS response (may take 12-18 months)

481(a) Adjustment Can Be Painful

When revoking MTM, you must "undo" prior MTM treatment. If you've deducted unrealized losses in prior years that later became gains, the Section 481(a) adjustment could create a large taxable gain in the year of change.

Example: You elected MTM in 2023 and deducted $100,000 of unrealized losses at year-end. In 2024, those positions recovered and show $80,000 unrealized gains. If you revoke MTM in 2025, the 481(a) adjustment would include the $100,000 previously deducted, creating taxable income.

Planning Tip

Before making the 475(f) election, model multiple years of scenarios. If there's significant risk you'll want to revoke, reconsider making the election in the first place.

IRS Examination Issues

The 475(f) election is a frequent examination target, particularly when large losses are deducted. Be prepared to defend both your trader status and the propriety of the election.

Common IRS Challenges

1. Trader Tax Status Denial

The IRS may assert you're an investor, not a trader. This disallows the entire MTM election.

Defense:

2. Late or Defective Election

The IRS may claim the election statement was not timely filed or didn't meet requirements.

Defense:

3. Failure to Identify Investment Positions

The IRS may assert that positions claimed as investments were not properly identified.

Defense:

4. Hobby Loss Rules

If you have consistent losses, the IRS may invoke IRC § 183 (hobby losses), disallowing deductions beyond income.

Defense:

5. Wash Sale Adjustments on Identified Securities

The IRS may apply wash sale rules to securities you claimed were excluded from MTM.

Defense:

Documentation Best Practices

To survive IRS examination, maintain:

Statute of Limitations

Election Checklist & Implementation Guide

Pre-Election Checklist

Election Filing Checklist

Post-Election Compliance Checklist

Deadline Calendar

Date Action Required Notes
December 31 Year-end MTM valuation Mark all trading positions to FMV; calculate unrealized gains/losses for tax return
January 1 Reset basis New tax basis equals December 31 FMV for all MTM positions
January - March Tax return preparation Report MTM gains/losses on Schedule C (or entity return)
March 15 Entity return deadline (unextended) S-corp (1120S) and partnership (1065) returns due; election must be attached if electing for following year
April 15 Individual return deadline (unextended) CRITICAL: Deadline to make 475(f) election for following year; attach to Form 1040 or extension request (Form 4868)
September 15 Entity return extended deadline Extended deadline for S-corp/partnership returns; election must be made by unextended deadline
October 15 Individual return extended deadline Extended deadline for Form 1040; election must be made by unextended deadline (April 15)

Unextended Deadline is Absolute

Remember: The April 15 (or March 15 for entities) unextended deadline for making the election is absolute. Filing a 6-month extension does not extend the election deadline.

Case Study: MTM Election in Action

Scenario

Trader Profile: Alex, full-time algorithmic trader

2024 Results (Without MTM)

Realized short-term gains$80,000
Realized short-term losses($150,000)
Net capital loss($70,000)
Wash sale disallowances$35,000
Deductible capital loss (capped)($3,000)
Carryforward($67,000)
W-2 salary from S-corp$60,000
Taxable income$57,000

2025 Results (With MTM Elected)

Realized trading gains/losses$120,000
Unrealized losses (Dec 31 positions)($40,000)
Total MTM income$80,000
Business expenses (software, data, office)($25,000)
Net trading business income (Schedule C)$55,000
W-2 salary from S-corp$60,000
Taxable income$115,000

2026 Results (MTM Continues, Loss Year)

Realized trading gains/losses($90,000)
Unrealized gains (Dec 31 positions)$10,000
Total MTM loss($80,000)
Business expenses($25,000)
Net trading business loss (Schedule C)($105,000)
W-2 salary from S-corp$60,000
Taxable income (loss)($45,000)
Tax refund from NOL~$15,000

Key Takeaways

Frequently Asked Questions

Can I make the election mid-year?

No. The election is effective beginning January 1 of the election year and must be made by the unextended due date of the prior year's return.

Can I elect MTM for my IRA or 401(k)?

No. Retirement accounts are already tax-deferred/tax-free and don't have separate taxable income. The 475(f) election applies only to taxable trading accounts.

Does MTM apply to cryptocurrency?

Unclear. The IRS treats cryptocurrency as property (not securities or commodities). IRC § 475(f)(1) applies to securities; § 475(f)(2) applies to commodities. Crypto likely doesn't qualify for either, though there's no definitive guidance. Consult a tax advisor for crypto trader tax planning.

Can I elect MTM for just part of my portfolio?

Yes, but only by identifying non-trading securities as investments before the close of the day acquired. The default is that all securities are subject to MTM unless you affirmatively identify them otherwise.

What if I made the election but don't qualify for TTS?

The election is invalid. The IRS will recharacterize your income as capital gains/losses and potentially assess penalties and interest. TTS qualification is a prerequisite for the 475(f) election.

Can I make the election if I have a full-time job?

Possibly, but it's more difficult. Having another full-time job undercuts the claim that trading is your primary business. However, if you trade before/after work and on weekends with sufficient frequency and volume, you may still qualify. Document extensively.

Does the election apply to options and futures?

Yes. The § 475(f)(1) election covers securities (including options on securities). The § 475(f)(2) election covers commodities (including futures and forex). You can elect one or both.

What happens to capital loss carryforwards when I elect MTM?

Prior capital loss carryforwards remain capital losses and can still be used against capital gains or up to $3,000 against ordinary income per year. They don't convert to ordinary losses.

Can I revoke the election if I stop trading?

Yes. If you cease the trading business entirely, you can revoke the election without IRS consent (automatic consent). Otherwise, you need IRS permission via Form 3115.

Additional Resources

IRS Guidance

Court Cases

Related Guides

Disclaimer: This guide provides general information about IRC Section 475(f) and is not tax advice. Tax law is complex, fact-specific, and subject to change. The 475(f) election is permanent (effectively) and has significant tax consequences. Consult a qualified tax professional experienced in trader taxation before making any elections or taking any tax positions.