December 31 Deadline for 2015 Gains and Losses
30.15 Mark-to-Market Election for Traders
A trader in securities may elect to have his gains and losses treated as ordinary gains and losses by making a mark-to-market election. As explained below, it is too late to make an election for 2015.
In the absence of an election, gains and losses of a trader are treated as capital gains and losses on Form 8949 and Schedule D.
30.15 • Mark-to-Market Election for Traders
If the mark-to-market election is made, you report trading gains and losses on closed transactions plus unrealized gains and losses on securities held in your trading business at the end of your taxable year as ordinary gains and losses on Form 4797. Trader profi ts are not subject to self-employment tax (45.1), whether or not the mark-to-market election is made. Th e unrealized gain or loss on a security that is reported on Form 4797 increases or reduces the basis of the security. For example, if you report an unrealized gain of $50 on stock with a cost of $100, you increase the basis of the stock to $150. If you later sell the stock for $90, you report a loss of $60 in the year of the sale.
Th e requirement to report unrealized gains and losses at the end of the year and to adjust basis of shares is a change in accounting method that requires you to fi le Form 3115 with the IRS National Offi ce and report required adjustments; see IRS Publication 550 for details.
Once the mark-to-market election is made, it applies to all future years unless the IRS agrees in writing to a revocation. Th e failure to fi le Form 3115 does not invalidate a timely and valid election. Requesting a revocation requires a Second Form 3115 and another user fee.
Making the election is not proof that you are actually a trader in securities. If you are audited by the IRS, you must be able to prove that your activities are such that you are in the business of making money by buying and selling over short periods of time. As mentioned in 30.14, there are no hard and fast rules that specify how many daily or short-term trades qualify you as a trader.
Th e mark-to-market election does not apply to the securities you hold for investment. Sales of your investment securities are reported on Form 8949 and Schedule D, not Form 4797.
When to make the mark-to-market election. Th e IRS requires you to make the election by the due date (without extensions) of the tax return for the year prior to the year for which the election is to be eff ective. Under this due date rule, it is too late to make an election for 2015, as this had to be done by April 15, 2015, the due date for your 2014 return. Th e election for 2016 must be fi led by April 18, 2016 (April 19 for residents of Maine and Massachusetts).
A regulation gives the IRS authority to grant an extension of time to fi le the mark-to-market election if the taxpayer has acted reasonably and in good faith and allowing relief does not prejudice the interests of the government. However, the IRS has refused to allow such extensions, claiming that a late election invariably results in prejudice to the interests of the government.
Th e Tax Court has supported the IRS in cases where the taxpayers, in fi ling their elections several years late, were relying on hindsight to try to gain a tax advantage from ordinary loss treatment.
Th e Ninth Circuit Court of Appeals has also refused to allow a late election where the taxpayer was relying on hindsight to try to gain a tax advantage. On his 1999 return, Acar reported over
$950,000 in losses from trading securities, treating them as capital losses. In early 2002, he fi led an amended return and tried to make a retroactive mark-to-market election beginning with 1999 so he could treat his 1999 losses as ordinary losses and claim a refund. Th e IRS disallowed the late election and a federal district court and the Ninth Circuit affi rmed. Allowing the late election would give Acar an advantage that was not available on April 15, 1999, the due date for making the election for 1999 under Revenue Procedure 99-17. When the late election was made, Acar knew that he had incurred losses and, with that hindsight, was trying to convert what had been capital losses on his original return into ordinary losses. It does not matter that any advantage from a late election for 1999 could be outweighed if Acar in later years realized trading gains that under the irrevocable election would have to be treated as ordinary rather than capital gains. Th at a taxpayer might come to regret an election in later years does not mean that hindsight was not used to gain an advantage at the time of the retroactive election.
In another case, the Tax Court was more sympathetic, allowing an extension to a taxpayer who fi led his election for 2000 on July 21, 2000, three months after the IRS deadline of April 17, 2000.
He had left his law practice and became a trader in January 2000. Th e accountant who prepared his 1999 return did not know about the mark-to-mark election but a friend told him about it in June 2000 and in July the taxpayer hired a law fi rm, which fi led the election for him and asked the IRS to allow the extension. Th e taxpayer did not conduct any trading activities between the date he should have fi led the election and the date he actually fi led it. Over IRS objection, the Tax Court allowed the late election on the grounds that the taxpayer had acted reasonably and in good faith by promptly employing the law fi rm after learning about the availability of the election. Since the taxpayer did not realize any further gains or losses between the date he should have fi led the election and when he actually did so, the Court held that the interests of the government were not prejudiced.
Planning Reminder
Wash Sale Rule Does Not Apply If you make a mark-to-market election, the wash sale rule does not apply; all losses are reported as ordinary losses under the mark-to -market rules
Mark-to-Market Election for Traders • 30.15 How to make the mark-to-market election. An election for 2016 must be made by April
18, 2016 (April 19 for residents of Maine and Massachusetts). Make the election on a statement attached to your original 2015 return fi led by April 18, 2016 (April 19 for residents of Maine and Massachusetts), or on a request for a 2015 fi ling extension (Form 4848) fi led by April 18, 2016 (April 19 for those in Maine and Massachusetts). Th e statement should specify that eff ective for the taxable year starting January 1, 2016, you are electing to report gains and losses from your trading business under the mark-to-market rules of Section 475(f). However, if you are not required to fi le a 2015 return, make the election for 2016 by placing a statement of election in your books and records no later than March 15, 2016. A copy of the statement must be attached to your original 2016 return.
One of the conditions of the election is that you must clearly distinguish between securities held for investment and trading purposes. Th e election applies only to the securities held in your trad- ing business, not to the securities held for investment. Holding investment securities in a separate account is advisable.
An election may not be revoked in a later year except with IRS permission.
In light of the accounting requirements and the overall eff ect of reporting unrealized gains and losses, before making the election you should consult a professional experienced in the use of mark-to-market accounting.
See IRS Revenue Procedure 99-17 for details on making the mark-to-market election.
Chapter 31
Tax Savings for Investors in Real Estate
Real estate investors may take advantage of the following tax benefi ts:
• Gains on the sale of investment property may be taxed at capital gain rates.
• Depreciation can provide a source of temporary tax-free income (31.1).
• Rental income can be used to off set passive losses Chapter 10.
• Tax-free exchanges make it possible to defer tax on exchanges of real estate held for investment (31.3).
However, real estate gains may be subject to the 3.8% net investment income tax (28.3).
Losses on real estate transactions may be subject to the following disadvantages:
• Rental losses may not be deductible from other income such as salary, interest, and dividends unless you qualify as a real estate professional or for the special $25,000 rental loss allowance under the passive loss rules Chapter 10.
• Compromises of mortgage liability may subject you to tax (31.10).
A foreclosure or repossession is treated as a sale on which you realize gain or loss. In addition, if you are personally liable on the loan and the amount of debt cancelled in the foreclosure exceeds the fair market value of the transferred property, you will owe tax on cancellation of debt income unless an exception is available (31.9).
31.1 Real Estate Ventures 557
31.2 Sales of Subdivided Land—Dealer or Investor? 558
31.3 Exchanging Real Estate Without Tax 559
31.4 Timing Your Real Property Sales 560
31.5 Cancellation of a Lease 560
31.6 Sale of an Option 561
31.7 Granting of an Easement 561
31.8 Special Tax Credits for Real Estate Investments 562 31.9 Foreclosures, Repossessions, Short Sales,
and Voluntary Conveyances to Creditors 563
31.10 Restructuring Mortgage Debt 564
31.11 Abandonments 565
31.12 Seller’s Repossession After Buyer’s Default on Mortgage 566 31.13 Foreclosure on Mortgages Other Than Purchase Money 567
31.14 Foreclosure Sale to Third Party 568
31.15 Transferring Mortgaged Realty 568
Real Estate Ventures • 31.1