Trader Tax Status and the Mark-to-Market Election: An Overview

This article is general information about US tax rules, not tax advice. The rules are complex and the stakes are high; work with a qualified tax professional.

Most people who buy and sell securities are investors for tax purposes, even if they trade often. A smaller group qualifies as traders in a trade or business, which changes how expenses can be treated and opens an option called the mark-to-market election. The IRS summarizes the rules in Topic 429, Traders in securities.

Investors, traders and dealers

• Investors buy and sell for dividends, interest and long-term appreciation. They report sales on Form 8949 and Schedule D.
• Traders run a business of trading for their own account. According to the IRS, you must seek to profit from daily market movements rather than dividends or long-term appreciation, your activity must be substantial, and you must trade with continuity and regularity.
• Dealers buy and sell securities with customers and must use mark-to-market accounting.

Calling yourself a day trader does not, on its own, make you a trader for tax purposes. The IRS looks at facts such as how often you trade, how long you hold, how much time you spend and whether trading is your livelihood.

What trader status changes

Without a mark-to-market election, a qualifying trader's gains and losses are still generally capital gains and losses. The main difference is that trading-related business expenses can be reported on Schedule C.

The section 475(f) mark-to-market election

Qualifying traders can elect mark-to-market accounting. With a valid election:

• Positions are treated as sold at fair market value on the last business day of the year.
• Gains and losses are generally ordinary rather than capital, and are reported on Form 4797.
• The wash sale rule and the $3,000 capital loss limit generally do not apply to those securities. See the wash sale rule and capital gains basics.

The trade-off: gains that would otherwise be long-term capital gains are taxed as ordinary income, and the election is hard to undo.

Deadlines

The IRS states that the election generally must be made by the original due date (without extensions) of the tax return for the year before the year it takes effect, and that late elections are generally not allowed. Revoking it requires following specific procedures.

Records matter even more

Claiming trader status means being able to show your activity: the number of trades, how often you traded, your holding periods and the time you spend. A complete trade history and journal support that. See trading records to keep.

In TradeThink

TradeThink keeps every trade with dates, holding times and fees, shows your number of trades and trading days on the calendar and reports, and can export your full history for your tax professional.