This page will provide you with the detail - in flowchart format - as well as an example of what your tax return will look like when complete.
We will use as our MTM examples, stock and option positions in AAPL, GILD, FB and BA. These securities, as well as the others used in this example, were chosen because of their movement and educational capacity and do not reflect any recommendations to buy or sell.
AAPL - 200 shs purchased, 9/15/2015 at $115/share
GILD - 500 shs purchased, 10/16/2015 at $102/share
Other trades - Form 1099-B Gross proceeds of $142,700 with corresponding cost basis of $139,500 + option net proceeds of $4,175
FB - 2 Feb 2017 puts with a 120 strike, sold 11/21/2016 for $5.55/contract
BA - a calendar call consisting of 5 Jun 2016 strike 140 long calls and 5 short Jan 2016 145 calls entered on 8/22/2016 and 11/21/16 for $7.40/contract and $ /contract, respectively
Expenses are the same as in the Reporting examples but repeated here:
Investment advisory newsletter - $600
Computer - $1,500 (exclusive use); MACRS 5-year, first year
Monitors - $900 (three); MACRS 5-year, first year
Furniture - $750 desk, monitor stand; MACRS 7-year, first year
Software - $300 Microsoft Office 2016; S-L 36 months, 12 months
Fiber optic data line - $40/month
Airfare & Hotel - $1,300
Meals & Entertainment - $200
TOTAL DEDUCTIBLE EXPENSES - $3,167
Note: The Airfare & Hotel and the Meals & Entertainment are NOT deductible for an Investor. See IRS Publication 550 pertaining to Nondeductible Expenses. The other expenses would be deductible on Schedule A as Miscellaneous Itemized Deductions.
Commissions, for this example, are ignored.
Roadmap for the MTM Election
The MTM Election template provides an Interactive Roadmap for critical dates.
Notes for Filing Tax Forms
Prepare the 481(a) adjustment before completing the Form 3115. The adjustment amount is required for Form 3115.
You will need to decide, if the 481(a) adjustment is less than $25,000, whether you will take the entire adjustment in the first year or over the next four years. If the adjustment is negative (a tax benefit) then it is required to be applied in the current year.
Form 3115 is both attached to the tax return and sent to the IRS National Office according to the Form 3115 instructions.
Make sure the 481(a) adjustment and year-end MTM adjustment ties to the Form 4797 amounts.
The year-end MTM adjustment amount (the ‘Current Market Value’ column on the worksheet) is your new basis for gain or loss in subsequent tax periods.
Form 6781, for our purposes, is used when trading index options. No index or index options are presented in this example. An example of a completed Form 6781 is included in Presentation 1 and 3 on the Presentations page.
It is a good idea to take a screenshot of your positions on your brokers position page and their respective prices on 12/31. Most brokerage statements for year-end report the open positions based upon Settlement Date but tax reporting is based on Trade Date. Thus, you will need some form of verification of the price at year-end for MTM calculations.
What Does IRC Sec 475(f) Actually Say?
IRC Sec 475(f)(1)
(A) In general. In the case of a person who is engaged in a trade or business as a trader in securities and who elects to have this paragraph apply to such trade or business—
(i) such person shall recognize gain or loss on any security held in connection with such trade or business at the close of any taxable year as if such security were sold for its fair market value on the last business day of such taxable year, and
(ii) any gain or loss shall be taken into account for such taxable year.
Proper adjustment shall be made in the amount of any gain or loss subsequently realized for gain or loss taken into account under the preceding sentence. The Secretary may provide by regulations for the application of this subparagraph at times other than the times provided in this subparagraph.
So, does that actually mean a CLOSING transaction instead of the literal SALE language used in the statute?
The Regulations and case law are silent on the issue. So let’s create a couple scenarios.
Scenario 1: Trader is short 500 shares of stock at year-end.
Is there a deemed PURCHASE (closing transaction) of those shares at year-end or because it is not a SALE is it ignored?
Scenario 2: Trader is involved in an options spread trade with STO and BTO transactions. Does the trader mark to market the BTO transaction (because it would be a sale) but not the STO transaction?
Scenario 2 could result in some onerous tax consequences if literally interpreted. For instance, the underlying for a short put vertical (bull put) significantly decreases at year-end. The trader would be forced to recognize the gain on the long put (a deemed sale) and not the corresponding loss on the short put (a deemed purchase).
Therefore, I believe the intent of Sec 475 was actually to ‘mark to market’ the open transactions at year-end and that the language of the statute is more appropriately read as “if such security were closed for its fair market value ...” at year-end.
Whatever position you take, however, should be applied consistently throughout the life of the trading entity/business.
An overview of how to make the Mark-to-Market Election for Traders in Securities
Mark-to-Market Election and Maintenance
Learn When and How to make the Mark-to-Market Election; Use the MTM Election template to Make and Maintain your MTM Election; Examine the Pros and Cons of the MTM Election