Section 475 MTM Accounting

TTS traders consider a Section 475 election for tax-loss insurance and a QBI deduction.

Traders eligible for trader tax status (TTS) have the option to make a timely election for the Section 475 accounting method on securities and/or commodities. Section 475 is mark-to-market (MTM) accounting with ordinary gain or loss treatment. Without it, securities traders use the realization (cash) method with capital gains and loss treatment, including wash sale loss adjustments and the annual $3,000 capital loss limitation. We call it tax-loss insurance.

Caution: Sole proprietor (individual) TTS traders who missed the Section 475 MTM election date (April 18, 2023, for 2023) can’t use ordinary-loss treatment and are stuck with capital gains and losses, perhaps capital-loss carryovers. You might prefer to skip a 475 election for 2024, due by April 15, 2024, if you need capital gains to use up capital loss carryovers from 2023, as 475 is ordinary income, especially if you have capital gains in Q1 2024. (We review the decision-making in Green’s 2024 Trader Tax Guide, chapter 2.)

A new entity (new taxpayer) could deliver Section 475 MTM on trading losses generated in the entity account if it filed an internal Section 475 MTM election within 75 days of inception. A new entity should be in business for a minimum of Q4 to establish TTS.

Ordinary losses offset all types of income (wages, portfolio income, and capital gains) on a joint or single filing, whereas capital losses only offset capital gains. 

Starting in 2021, Section 475 ordinary losses and business expenses are subject to the 2017 Tax Cuts and Jobs Act (TCJA) “excess business loss” limitation (EBL). Ordinary business losses over the EBL threshold are NOL carryforwards. The inflation-adjusted EBL limit is $578,000/$289,000 (married/other taxpayers) for 2023 and $610,000/$305,000 (married/other taxpayers) for 2024. The TCJA repealed NOL carrybacks (except for farmers) and limited NOL carryforwards to 80% of the subsequent year’s taxable income.

TCJA also offers a 20% qualified business income (QBI) tax deduction for pass-through business partnerships and S-Corps, including sole proprietors. TTS trading is a specified service trade or business, so there is an income threshold and cap. QBI includes 475 ordinary income, excluding capital gains and losses, portfolio income, and forex. TTS expenses are negative QBI. A profitable TTS/475 trader is eligible for the QBI deduction, provided their taxable income is not over the QBI thresholds.

By making a 475 election on securities only, TTS traders retain lower 60/40 capital gains rates on Section 1256 contracts (futures).

Securities traders can segregate investment positions for long-term capital gains. If there is an overlap in securities trades vs. taxable investment positions, consider an entity for ring-fencing TTS/475 from segregated investment positions on the individual level.

Section 475 election procedures

Existing taxpayer individuals who qualify for TTS and want Section 475 must file a 2024 Section 475 election statement with their 2023 tax return or extension by April 15, 2024. The second step of a 2024 Section 475 election is to file a 2024 Form 3115 with the 2024 tax return in 2025. (Existing partnerships and S-Corps will file similarly by March 15, 2024.)

Revised excerpt from Green’s Trader Tax Guide Chapter 2 Section 475 MTM Accounting