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Can I write off trading expense (e.g. home office expense) using Sec. 475 Mark-to-Market income?

I am a stock trader (TTS) - sole proprietorship. Would I need earned income (get a W2 job or self-employment income stream) to write off trading expense (e.g. home office expense) or making Sec. 475 Mark-to-Market election for my stock trading account is enough?

 

Also, if my brokerage firm doesn't offer mark-to-market accounting, can I simply use the beginning account value of Jan and ending account value of Dec, which are easily available in any broker's monthly statements, to get the 475 income that year? I only trade stocks, or selling naked puts or covered calls.

 

Thanks!

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Can I write off trading expense (e.g. home office expense) using Sec. 475 Mark-to-Market income?

you don't need earned income to take the HO deduction. You do have to be engaged in a business (which trader is) and meet the other rules. A MTM election is not needed but you do have to qualify as a trader (as opposed to investor) in your circumstances  

 

you can't make the MTM election without filing the required paperwork with the tax return (or extension) on or before its original due date that you will start using the MTM election in the following year. Late elections are rarely allowed. so the best you can do is make the MTM election with your 2023 return or extension filed on or before 4/15/2024 stating that you will be using the MTM accounting starting in 2024. The fact that your financial institution doesn't have a provision to handle MTM can create a reporting mess. it will report the

sales on form 1099-B and you won't (see below). You may expect an IRS inquiry. With MTM there are no wash sales because you pick up in your tax return in the first reporting year any unrealized gain or loss that exists at year-end and a 481a adjustment, as available, for the unrealized gain/loss that exists at the beginning of the first tax year. After the first year, your profit/loss is determined by using the market value of trading securities held at the beginning and end of the tax year.  

*****************

it may be best to have a pro evaluate your trading activities to determine if you qualify and prepare the paperwork for the return. 

*****************

more info for traders

To be engaged in business as a trader in securities, you must meet all of the following conditions:
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).
Traders report their business expenses on Schedule C. Commissions and other costs of acquiring or disposing of securities aren't deductible but must be used to figure gain or loss upon disposition of the securities. Gains and losses from being a trader aren't subject to self-employment tax.
Traders can choose to use the mark-to-market rules, but investors can't. If a trader doesn't make a valid mark-to-market election under section 475(f), then he or she must treat the gains and losses from sales of securities as capital gains and losses and report the sales on Schedule D/ Form 8949 as appropriate. Trading gains/losses are reported on Part II of Form 4797.
A trader must make the mark-to-market election by the original due date of the tax return for the year before the year for which the election becomes effective. You can make the election by attaching a statement either to your timely filed income tax return if filed without an extension or with a timely filed request for an extension of time to file your return. The statement should include the following information:
That you're making an election under section 475(f);
The first tax year for which the election is effective (that is, the tax year for which a timely election is being made); and
The trade or business for which you're making the election.
Refer to the Instructions for Schedule D (Form 1040 or 1040-SR), Capital Gains and Losses for more information on how to make the mark-to-market election. It's important to note that in general, late section 475(f) elections aren't allowed.
After making the election to change to the mark-to-market method of accounting, you must change your method of accounting for securities under Revenue Procedure 2022-14, Section 24.01. In addition to making the election, you'll also be required to file Form 3115, Application for Change in Accounting Method. (This is for reporting the unrealized gain/loss at the beginning of the year the election is to be effective. See PUB 550 section  "Special Rules for Traders in Securities."  
If you've made a valid election under section 475(f), the only way to stop using mark-to-market accounting for securities is to file an automatic request for revocation under Revenue Procedure 2022-43, Section 24.02. Under that revenue procedure, the request for revocation must be filed by the original due date of the return (without regard to extensions) for the taxable year preceding the year of change (the year of change is the first taxable year the revocation is to be effective). This revocation notification statement must be attached to either that return or if applicable, to a request for an extension of time to file that return. Late revocations won't generally be allowed.

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9 Replies

Can I write off trading expense (e.g. home office expense) using Sec. 475 Mark-to-Market income?

you don't need earned income to take the HO deduction. You do have to be engaged in a business (which trader is) and meet the other rules. A MTM election is not needed but you do have to qualify as a trader (as opposed to investor) in your circumstances  

 

you can't make the MTM election without filing the required paperwork with the tax return (or extension) on or before its original due date that you will start using the MTM election in the following year. Late elections are rarely allowed. so the best you can do is make the MTM election with your 2023 return or extension filed on or before 4/15/2024 stating that you will be using the MTM accounting starting in 2024. The fact that your financial institution doesn't have a provision to handle MTM can create a reporting mess. it will report the

sales on form 1099-B and you won't (see below). You may expect an IRS inquiry. With MTM there are no wash sales because you pick up in your tax return in the first reporting year any unrealized gain or loss that exists at year-end and a 481a adjustment, as available, for the unrealized gain/loss that exists at the beginning of the first tax year. After the first year, your profit/loss is determined by using the market value of trading securities held at the beginning and end of the tax year.  

*****************

it may be best to have a pro evaluate your trading activities to determine if you qualify and prepare the paperwork for the return. 

*****************

more info for traders

To be engaged in business as a trader in securities, you must meet all of the following conditions:
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).
Traders report their business expenses on Schedule C. Commissions and other costs of acquiring or disposing of securities aren't deductible but must be used to figure gain or loss upon disposition of the securities. Gains and losses from being a trader aren't subject to self-employment tax.
Traders can choose to use the mark-to-market rules, but investors can't. If a trader doesn't make a valid mark-to-market election under section 475(f), then he or she must treat the gains and losses from sales of securities as capital gains and losses and report the sales on Schedule D/ Form 8949 as appropriate. Trading gains/losses are reported on Part II of Form 4797.
A trader must make the mark-to-market election by the original due date of the tax return for the year before the year for which the election becomes effective. You can make the election by attaching a statement either to your timely filed income tax return if filed without an extension or with a timely filed request for an extension of time to file your return. The statement should include the following information:
That you're making an election under section 475(f);
The first tax year for which the election is effective (that is, the tax year for which a timely election is being made); and
The trade or business for which you're making the election.
Refer to the Instructions for Schedule D (Form 1040 or 1040-SR), Capital Gains and Losses for more information on how to make the mark-to-market election. It's important to note that in general, late section 475(f) elections aren't allowed.
After making the election to change to the mark-to-market method of accounting, you must change your method of accounting for securities under Revenue Procedure 2022-14, Section 24.01. In addition to making the election, you'll also be required to file Form 3115, Application for Change in Accounting Method. (This is for reporting the unrealized gain/loss at the beginning of the year the election is to be effective. See PUB 550 section  "Special Rules for Traders in Securities."  
If you've made a valid election under section 475(f), the only way to stop using mark-to-market accounting for securities is to file an automatic request for revocation under Revenue Procedure 2022-43, Section 24.02. Under that revenue procedure, the request for revocation must be filed by the original due date of the return (without regard to extensions) for the taxable year preceding the year of change (the year of change is the first taxable year the revocation is to be effective). This revocation notification statement must be attached to either that return or if applicable, to a request for an extension of time to file that return. Late revocations won't generally be allowed.

Can I write off trading expense (e.g. home office expense) using Sec. 475 Mark-to-Market income?

Thank you very much @Mike9241 ! I am not sure why I am under the impression that if someone's only income is the trading income, if they don't make the mark-to market election, their business expense on schedule C will be carried forward and can't deducted against the capital gain in the same year. If they make the mark-to-market election, their income will become ordinary income but still not earned income. Not sure if it has to be earned income but I don't see it is being advertised anywhere as a benefit (don't have to get other W2 or contractor jobs) of mark-to-market election.

 

Then if I don't really lose money when trading, the main benefit for me to make the mark-to-market election would be that I would be able to get the 20% Qualified Business Income Deduction if I make less than the income limit because QBI doesn't apply to capital gain?

Can I write off trading expense (e.g. home office expense) using Sec. 475 Mark-to-Market income?

trading profits when MTM used and schedule C income/loss from trading are not earned income courtesy of the tax laws passed by Congress. 

Can I write off trading expense (e.g. home office expense) using Sec. 475 Mark-to-Market income?

@Mike9241 Qualified Business Income Deduction (QBI) doesn't seem to apply to capital gain? but also doesn't have to apply to only "earned" income, right? https://www.irs.gov/newsroom/qualified-business-income-deduction But because MTM income is on schedule C, how to get the 20% QBI in TurboTax? 

ThomasM125
Employee Tax Expert

Can I write off trading expense (e.g. home office expense) using Sec. 475 Mark-to-Market income?

After you enter your business income and expenses in the Self-employment income and expenses section of TurboTax you will see an option on the Business summary page that says Qualified Business Income. Click on the Details box next to it and you will be asked questions to determine if you qualify for Qualified Business Income (QBI) deduction. You may also see questions relating to the QBI deduction after you enter your business income and expenses.

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Can I write off trading expense (e.g. home office expense) using Sec. 475 Mark-to-Market income?

@ThomasM125 I did exactly the same but when I enter my Mark-to-Market trading income using form 4749 (https://ttlc.intuit.com/turbotax-support/en-us/help-article/income/report-trader-activity-without-se...), the QBI doesn't seem to pick up income from form 4749. Can we associate Form 4749 with a specific business in Turbotax? Other than trading (sole proprietorship), I have another LLC.

 

More urgently, I am also trying to figure out SEP IRA contribution for 2023 (because I am late for solo 401k) which also doesn't tie to a specific business. But when calculating QBI, don't we need to use gross income - business expense - home office - SEP IRA contribution to get the net profit of the LLC, and then do 20%? On the SEP IRA worksheet (Turbotax desktop) the net profit included my LLC expense and my trading schedule C expense but did not include my LLC income (1099-NEC).

Can I write off trading expense (e.g. home office expense) using Sec. 475 Mark-to-Market income?

@ThomasM125 bug in program see last line in this thread

@daisy20222023 MTM income under IRC 475 is not reported on schedule C but in part II of form 4797. thus schedule C only shows trading expenses.

for QBI if you're using desktop Turbotax go to forms mode 

 

1) Scroll down to the section of Schedule C, named "Qualified Business Income Deduction Smart Worksheet".

2) Go to line "F2, Adjustments to qualified business income".

3) Type the amount of the MTM income/loss from 4797, into this adjustments field. The income should now appear in the associated QBI worksheets and calculations.

 

in online 

wages and income

business items under this

business income expenses  click on the start or update icon to the right

then next page click on edit

you get to a screen about QBI so check yes, then continue

you get to a page that says uncommon situations

check the box that the income needs to be adjusted

enter the 4797 amount

BUG this puts the amount on E2 when it belongs on F2 but the QBI calculation is correct

 

 

Can I write off trading expense (e.g. home office expense) using Sec. 475 Mark-to-Market income?

@Mike9241 It's working now! Now just the SEP IRA contribution went to both my LLC and my trading Sole Proprietorship. I see them in the QBI Deduction Smart Worksheet of both.

 

By the way, I know sometimes the IRS delays the deadline to contribute to retirement plans such as when there are disasters in some counties. Is it too late in California now to contribute to 2023 solo 401K, or convert some traditional IRA to Roth IRA to be counted as part of 2023?

Can I write off trading expense (e.g. home office expense) using Sec. 475 Mark-to-Market income?

The IRS allows SEP-IRA contributions to be made by the return due date. If the return is extended the due date is the extended due date. Can't answer for California if it's the same rules. 

too late to do any conversions for 202. 

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