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MARK-TO-MARKET ELECTION Sec. 475(f) mark-to-market election is that all losses
If a day trader who qualifies as a trader in from the trading activity (whether the losses are
securities makes the Sec. 475(f ) mark-to-market from actual trades made during the year or from
election, the day trader treats all the gains or marking to market all securities held at the close of
losses from his or her trading activity as ordinary the year) are treated as ordinary losses rather than
gains or losses that must be reported on Part II capital losses. Thus, the $3,000 capital loss limitation
of Form 4797, Sales of Business Property. Neither does not apply to the losses from the trading activity
the limitation on capital losses nor the wash-sale if the election is made, and the trader can use the
rules apply to the trader after making the election full amount of the net losses from his or her trading
to use the mark-to-market method of account- activity to offset ordinary income from other sources.
ing. In addition, securities the day trader holds Losses that cannot be used in the current year are
at the close of the year are marked to market carried forward as net operating losses.
by treating the securities as being sold for fair While gains from the trading activity will
market value (FMV) on the last business day of likewise be treated as ordinary income, for day
the tax year, with the gain or loss recognized on traders this will generally not result in a higher tax
the deemed sales taken into account for that tax rate being paid on the gains because, due to the
year. Despite the change in characterization of nature of day trading, most or all of the gains from
income, a day trader who qualifies as a trader in the trading activity will be short-term capital gains.
securities is still not subject to self-employment Furthermore, if a day trader purchases a security
tax on the sales of securities after making the Sec. that he or she anticipates will be held long term, the
475(f) election. security can be removed from the mark-to-market
Making the Sec. 475(f) election does not change regime and treated as held for investment if the
the day trader’s treatment of his or her expenses day trader clearly identifies in his or her records
from the trading activity. The expenses are treated (before the close of the day the security is acquired)
as deductible business expenses that are reported on that the security is not connected to his or her day
Schedule C. trading activity.
Because day traders making the Sec. 475
MAKING THE ELECTION election must mark securities held at the close of
The Sec. 475(f) mark-to-market election must be the year to market, causing the recognition of the
made on the tax return for the year prior to when otherwise unrealized gain or loss in the securities,
the taxpayer wants it to take effect. For example, the income subject to tax and the tax liability of a
for the mark-to-market election to be effective day trader may be lower (if there is a net unrealized
for 2024, a day trader who qualifies as a trader in loss in the securities) for a year if the election is
securities must make the election by the original made. However, if there is an unrealized gain on the
due date of the 2023 tax return (not including securities, the election will generally result in more
extensions). The election is made by attaching a income subject to tax and a higher tax liability.
statement to the income tax return (or to a request The table “Quantifying the Effects of the Election”
for an extension of time to file that return) that on p. 40 shows the tax results for a day trader without
includes the following information: and with a Sec. 475(f) election in three scenarios:
■ That an election is being made under Sec. 475(f); Scenario 1: A day trader, who qualifies as a
■ The tax year when the election will become trader in securities, has net realized losses from sales
effective; of securities during 2021 of $25,000, has $10,000
■ The trade or business for which the election is of trading expenses, and holds no securities at the
being made (see Rev. Proc. 2018-31; see also close of the year. The trader also receives $95,000 of
IRS Topic No. 429). ordinary income from other sources and takes the
A day trader who makes the election will standard deduction.
also be required to change his or her method of Scenario 2: A day trader, who qualifies as a
accounting for securities under Rev. Proc. 2019-43 trader in securities, has net realized short-term
by filing a Form 3115, Application for Change in gains from sales of securities during 2021 of
Accounting Method. $30,000, has $10,000 of trading expenses, and holds
no securities at the close of the year. The trader also
BENEFIT OF MAKING THE SEC. 475(F) ELECTION receives $95,000 of ordinary income from other
The primary benefit to a day trader of making the sources and takes the standard deduction.

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