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Trader
Level 3

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

For my seasoned daytraders or tax experts, I recently took up daytrading and I heard about the tax stuff and got a little scared. So my question is Sec. 475 Mark-to-market Election. In order to claim it for the 2021 Tax year, can I file the election when I file my taxes in 2022 for 2021? Or did I need to file the Election last year for this year?

 

I know, noob question, but a serious one. So please help, because my opinion is that it would not make sense to have to file an election for the current year in a previous year. Like literally until about a month and half ago, I had no idea I was going to take up daytrading. Decided to give it a go and I am up overall, but I traded some of the same stocks without waiting for the 30 day rules. So my issue is that even though I am up 7.6% overall, will the IRS be like "nah you are actually up 50% overall" and tax the hell out of me. Which at that point, I need to stop now and maybe get back to it next year.

 

So please help an aspiring daytrader, I am completely confused on this and it seems weird to make an election for the current tax year in a previous year's return.

2 Best answer

Accepted Solutions
Critter-3
Level 15

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

The election must be made on a timely filed return for the year prior to the election taking effect ... so it is too late to file the election for the 2021 tax return.   The election for the 2022 tax year must be made on the timely filed 2021 return next year. 

 

Per the IRS:  https://www.irs.gov/taxtopics/tc429

 

A trader must make the mark-to-market election by the original due date (not including extensions) of the tax return for the year prior to the year for which the election becomes effective. You can make the election by attaching a statement either to your income tax return if filed without an extension or to a request for an extension of time to file your return. The statement should include the following information:

  1. That you're making an election under section 475(f);
  2. The first tax year for which the election is effective (that is, the tax year for which a timely election is being made); and
  3. The trade or business for which you're making the election.

View solution in original post

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MMTaxMM
Level 10

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

So say I trade XYZ stock every month, but suffer a loss in one month. Does that loss ever get deducted? Even if I stop trading it in October?

Yes. All of your CLOSED positions are "deducted" no matter what. The problem comes in where you have a loss in XYZ on a buy/sell and then open another buy position in XYZ. What happens then is your loss is not recognized but that loss is added to the basis of your XYZ position.

I mean as in this is the amount I actually made, which as it stands now is 12K.

What I mean is paper losses are realized while actual losses are recognized for tax purposes unless you elect MTM or there is some law or reg that says otherwise.....like the wash sale rule. In a wash sale you realize a loss but you do NOT recognize the loss for tax purposes until you close the position.

As the IRS would be taxing me on literally no gains, if the losses never take effect.

The losses take effect.....are recognized.....IF you close your loss positions OR if you elect MTM. 

 

View solution in original post

24 Replies
Critter-3
Level 15

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

The election must be made on a timely filed return for the year prior to the election taking effect ... so it is too late to file the election for the 2021 tax return.   The election for the 2022 tax year must be made on the timely filed 2021 return next year. 

 

Per the IRS:  https://www.irs.gov/taxtopics/tc429

 

A trader must make the mark-to-market election by the original due date (not including extensions) of the tax return for the year prior to the year for which the election becomes effective. You can make the election by attaching a statement either to your income tax return if filed without an extension or to a request for an extension of time to file your return. The statement should include the following information:

  1. That you're making an election under section 475(f);
  2. The first tax year for which the election is effective (that is, the tax year for which a timely election is being made); and
  3. The trade or business for which you're making the election.
Rick19744
Level 12

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

You need to get up to speed on the mechanics of day trading as a vast majority of individuals get into trouble.

Since you are day trading, and most of your transactions are short term, the wash sale rules really come into play towards the end of the year.  This is where you need to be cognizant of open transactions, closed transactions and making sure you don't trade the same stock within the wash sale window.

Keep a list of "no trade" stocks towards the end of the year.

*A reminder that posts in a forum such as this do not constitute tax advice.*
Trader
Level 3

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

Thank you very much.

Just a ramble to myself and on the topic, but this rule seems crazy. Like it basically means I needed to be able to see the future and that the IRS is essentially taxing losses as if they were gains. I see people talking about income taxes being high, but taxing losses as gains is another level of crazy.

So please correct me if I am wrong on this. So to my understanding even though I am only up $12K, the IRS will treat me as if am up $22K (If am calculating the Wash Sales correctly)?

Crazy, here I was thinking I was some trading savant to make $12k in less then 2 months by scalping stocks, I even recommended daytrading to a friend. Also just realized that I even started after the tax deadline.

In addition, as for my friend who tried to follow me and they lost money, will the IRS treat their losses as gains as well, even though they lost money overall? If so, I need to warn them right away.

Again thank you very much.

Trader
Level 3

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

Same reply, just also want your take on it as well. Thank you both for answering my question.

Thank you very much.

Just a ramble to myself and on the topic, but this rule seems crazy. Like it basically means I needed to be able to see the future and that the IRS is essentially taxing losses as if they were gains. I see people talking about income taxes being high, but taxing losses as gains is another level of crazy.

So please correct me if I am wrong on this. So to my understanding even though I am only up $12K, the IRS will treat me as if am up $22K (if am calculating the Wash Sales correctly)?

Crazy, here I was thinking I was some trading savant to make $12k in less then 2 months by scalping stocks, I even recommended daytrading to a friend. Also just realized that I even started after the tax deadline.

In addition, as for my friend who tried to follow me and they lost money, will the IRS treat their losses as gains as well, even though they lost money overall? If so, I need to warn them right away.

"Keep a list of "no trade" stocks towards the end of the year."

Wouldn't I need to keep that list pretty much every time I make a trade?

Again thank you very much.

Critter-3
Level 15

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

Basic info ... the unallowed losses on wash sales are added to the basis of the new stock purchased.  Stop doing wash sales and the losses are automatically released on the final sale.  Do not repurchase that stock for another 30 days to stop the wash sale  restrictions.

 

For instance ...

 

Buy XYZ for  $10   and sell for  $5 ... reported loss is $5 if you don't repurchase the stock. 

 

 

But if you rebuy the stock within 30 days  say at $4 then the prior loss is not allowed and will be a zero gain/loss on the return for the original sale  and the  unallowed loss is added to the basis of the new stock bought so now you have a basis of $9 ($4 + $5).

 

Sell that new stock for $10 and you have a $1 gain,  sell it for $7 and you have a $2 loss which is deducted on the return   UNLESS YOU BUY IT AGAIN and the wash sale rules comes back into play.

 

Good news is the broker should be keeping track of this for you and it should be handled on the 1099-B you get next year ... talk to the broker to see how they handle this and/or do some reading on the subject. 

 

 

Mike9241
Level 15

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

you probably should consult with a tax pro as to the 475 election. being a daytrader does not automatically qualify you to make a valid election.  they can review your activity and advise you as to whether you qualify. here are the IRS criteria - you'll notice there are no numbers as to the number of trades or hours you must spend. 

You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation;
Your activity must be substantial; and
You must carry on the activity with continuity and regularity.
The following facts and circumstances should be considered in determining if your activity is a securities trading business:
Typical holding periods for securities bought and sold;
The frequency and dollar amount of your trades during the year;
The extent to which you pursue the activity to produce income for a livelihood; and
The amount of time you devote to the activity.
If the nature of your trading activities doesn't qualify as a business, you're considered an investor and not a trader. It doesn't matter whether you call yourself a trader or a day trader, you're an investor. A taxpayer may be a trader in some securities and may hold other securities for investment. The special rules for traders don't apply to those securities held for investment. A trader must keep detailed records to distinguish the securities held for investment from the securities in the trading business. The securities held for investment must be identified as such in the trader's records on the day he or she acquires them (for example, by holding them in a separate brokerage account).

 

the IRS has audited some taxpayers making the election and found that they weren't doing enough trading or spending enough hours. It then goes back to the earliest year and treats the trades as if the taxpayer was an investor and thus subject to wash sale rules. schedule C deductions are eliminated. as a result the taxpayer usually gets a big tax bill.

 

 

Trader
Level 3

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

Thank you, I love you all for answering my questions.

"Good news is the broker should be keeping track of this for you and it should be handled on the 1099-B you get next year ... talk to the broker to see how they handle this and/or do some reading on the subject."

That is actually what brought me here, I read multiple articles from reliable sources like Forbes, Financial Times to my broker TDAmeritrade all with different info and even saw horror articles like this one.

https://www.forbes.com/sites/shaharziv/2021/03/26/robinhood-trader-may-face-800000-tax-bill/?sh=23ca...

 

"Sell that new stock for $10 and you have a $1 gain, sell it for $7 and you have a $2 loss which is deducted on the return UNLESS YOU BUY IT AGAIN and the wash sale rules comes back into play."


So I think I understand now why Rick said this:

"Keep a list of "no trade" stocks towards the end of the year."

So basically as long as I stop say at the end of November and don't touch any stocks, the losses still count? Am I understanding that correctly?

 

If that is the case then I have to assume that the trader with the 800k tax bill on money that does not even exist never stopped trading the same stocks and that as long as I take a 31 day break before the end of the year I am fine? What about the 3K Capital Loss limitations?

Trader
Level 3

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

"You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation;
Your activity must be substantial; and
You must carry on the activity with continuity and regularity.
The following facts and circumstances should be considered in determining if your activity is a securities trading business:
Typical holding periods for securities bought and sold;
The frequency and dollar amount of your trades during the year;
The extent to which you pursue the activity to produce income for a livelihood; and
The amount of time you devote to the activity."

 

Check, I think I qualify if not more then the issue for me is the whole "you needed to elect on last years tax return for this year's tax return" thing. I started back at the beginning of June, started a Fintwit account, subscribed to a stock news service, joined multiple discords, opened and funded my brokerage Cash Account and devoted time to study. I seemed a natural or either very lucky because in less then 2 months I earned an overall of 12K on a 25k account bringing it to a total of 37k and some change. I only make 3k a month at my current employment and I probably spent more then 40 hours a week devoted to trading and more if you count studying.

However, its not like I did not make any mistakes, some of my trades and scalps were bad. So while in reality I only made 12K, the whole Wash Sale rule, if I calculated the Wash Sales would make it look like I made 22K. So basically I am scared I may get taxed on 10k that does not even exist and I definitely did not profit from.

 

Honestly, when I found out that I could get taxed on non-existent money I told my wife "Now I know why 90% of traders lose, its not the market, its the IRS".

Rick19744
Level 12

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

No.  It is not the IRS that is the problem.  The wash sale rules are not what cause most traders to lose money.

The wash sale rules were put in place to avoid "playing games" at the end of the year.

Being able to claim trader tax status (TTS) is not accomplished by any election; it is an optional tax status and is based on facts and circumstances each year.  So someone can qualify as a TTS in one year and not the next.

Qualifying for TTS is a subjective test based on case law:

  • trading activity must be substantial, regular, frequent and continuous, and
  • the taxpayer must seek to catch swings in daily market movement and attempt to profit from the short-term changes instead of looking at longer term holding investments.

Volume, frequency and average holding period are key items that the IRS will look at.

Based on a tax court case, leading commentators recommend an average of 4 trades per day, four days a week, 16 trades per week, 60 trades per month and 720 per year on an annualized basis.

Holding a regular job, as noted in one of your responses, may cause higher scrutiny.

Keep in mind, that TTS doesn't change how you report your gains and losses; they will still be short-term gains and losses subject to ordinary income and capped at the $3,000 per year in loss limitation.

The only way around that, is the Section 475 election.

What the TTS allows the taxpayer to accomplish is to take expense deductions on Schedule C.

Staying informed and staying ahead of the wash sale rules at the end of the year will be key.

Good luck.

*A reminder that posts in a forum such as this do not constitute tax advice.*
Trader
Level 3

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

No. It is not the IRS that is the problem. The wash sale rules are not what cause most traders to lose money.

Your likely right on this, but taxing money that does not exist does seem to be a genuine reason why traders lose money after I researched it. I seen numerous horror articles, not just that one I posted. I seen others where a trader may have made say 20K in reality, but the IRS says they owe them like 100k or more. Effectively taxing 80K that does not exist.

Being able to claim trader tax status (TTS) is not accomplished by any election; it is an optional tax status and is based on facts and circumstances each year. So someone can qualify as a TTS in one year and not the next.

 

But the election still must be made on the prior years taxes for the coming tax year?

Volume, frequency and average holding period are key items that the IRS will look at.

Based on a tax court case, leading commentators recommend an average of 4 trades per day, four days a week, 16 trades per week, 60 trades per month and 720 per year on an annualized basis.

 

Check, as mentioned above I have more then done this and even devoted what could be termed as start-up expenses to it, monitors, stock news services and upgraded my internet service.

 

"The wash sale rules were put in place to avoid "playing games" at the end of the year."

 

So this part is wrong, it does not matter if I stop 31 days before the end of the year to let the stocks cool off and the losses take hold? Because I can still keep the 720 trades and stop in November, that is not an issue for me. However, will the losses be capped at 3K? So take my current Wash Sales of approximately 10K, will the IRS say that only 3K of those count, even if I stop 31 days before the end of the year?

"What the TTS allows the taxpayer to accomplish is to take expense deductions on Schedule C.

Staying informed and staying ahead of the wash sale rules at the end of the year will be key.

Good luck."


Definitely and thank you for answering all of my questions, and helping me greatly. I definitely am researching this topic in other avenues. It just surprising how much of the info actually contradicts each other.

Critter-3
Level 15

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

@Trader 

 

We on this public forum do not need convincing ... keep your records in order for the IRS audit that may come your way ... they are the ones you must convince that you meet the definition of a trader.  

Trader
Level 3

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

"We on this public forum do not need convincing ... keep your records in order for the IRS audit that may come your way ... they are the ones you must convince that you meet the definition of a trader. "

Okay, was not trying to convince anyone just replying to what people said and trying to keep their answers on topic. Like don't get my response here wrong, I appreciate all of your replies, its just you can clearly see that my response about meeting the criteria was in response to others doubting that I meet the criteria. Which takes the discussion off topic, because yeah the IRS is the ones who decide if I meet the criteria. So that is something that even really should not be discussed and goes off topic.

As I said, I appreciate all of your responses and even upvoted every response here, but off topic responses are off topic responses. I have every right to respond and try to keep the replies to on topic discussion about when someone can apply for and when the Sec 475 Mark to Market Election would actually take effect. Which I have done very politely and even upvoted their responses knowing it had nothing to do with the original question.

As you can see there have been 91 people who have looked at this discussion and I am likely not the only one researching this now. So taking the conversation off topic and making it about me personally on whether I qualify is wrong. Thank you in advance for understanding this.

@Critter-3 With that standing please give my your response to my previous reply:
@Critter-3I would also like to thank you for being the one who has replied twice to the discussion with on topic info so far. So please recognize that my other responses were responses to people taking the discussion off topic.

"Sell that new stock for $10 and you have a $1 gain, sell it for $7 and you have a $2 loss which is deducted on the return UNLESS YOU BUY IT AGAIN and the wash sale rules comes back into play."


So I think I understand now why Rick said this:

"Keep a list of "no trade" stocks towards the end of the year."

So basically as long as I stop say at the end of November and don't touch any stocks, the losses still count? Am I understanding that correctly?

 

If that is the case then I have to assume that the trader with the 800k tax bill on money that does not even exist never stopped trading the same stocks and that as long as I take a 31 day break before the end of the year I am fine? What about the 3K Capital Loss limitations?

Critter-3
Level 15

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

Technically the wash sale rules come into play if you buy the same stock within the 30 day period  BEFORE or AFTER the sale for a loss.  

 

https://www.investor.gov/introduction-investing/investing-basics/glossary/wash-sales

Trader
Level 3

Sec. 475 Mark-to-Market Election Question and Tax Year It Is Effective?

"Technically the wash sale rules come into play if you buy the same stock within the 30 day period  BEFORE or AFTER the sale for a loss.  

 

https://www.investor.gov/introduction-investing/investing-basics/glossary/wash-sales"

 

@Critter-3 So like a Swing Trade? If I bought say some stock last week and then bought another set of the same stock yesterday. Sold the original set yesterday and then sold the second set next week. The 30 days for both sets would still not take effect until I sold the second set next week.

Just to note, that is a hypothetical situation I am using to further the response. I have stuck to daytrading and scalping so far.

So once both sets are sold, all I would need to do is wait 31 days to book any loss associated with the stock? Which means all I need to do is be done by the end of November, then any loss associated with any Wash Sales would become realized?

 

For me its more about understanding why some of these traders have huge tax bills and why the IRS does not just go off of Cost Basis and Net Gains. Because this seems to be the only profession where the IRS taxes money that does not actually exist. However, if it is just these traders not wanting to take 31 days off, then to me it sounds easy to avoid, just completely stop trading in November and wait for the rest of the year and re-start in January.

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