OptionsTaxGuy

This is partially addressed in the Internal Revenue Code and Regulations and depends in no small part on which way the transfer is directed ... from the non-MTM account to the MTM account or vice versa.  However, the statutory guidance [IRC Sec 475(f)(1)(B) and Prop Regs Sec 1.475(f)-2(a)] indicates that the investment security should not be identified with the MTM securities.  This precludes an investment security being transferred into a trading account or purchased in the MTM trading account with the intent of treating it as an investment security.

The requirement of Sec 475(f)(1)(B) is to clearly identify any security "having no connection" to the trading account and then to segregate that security into a non-trading account [Regs 1.475(f)-2(a)(3)]. 

 

Here are some possible reasons to transfer securities between investment and MTM trading accounts:

1. Unrealized loss exceeding the $3,000 limitation in an investment account - transfer to MTM account in order to deduct the entire loss against ordinary income

2. Substantial unrealized gain in a MTM account - transfer to investment account to secure long-term or short-term capital gain in order to offset against existing investment losses

 

So why can a taxpayer not transfer a security with a built-in loss - Scenario 1 - from an investment account to a MTM account during the year and thus bypass the $3,000 net capital loss limititation?

 

A search of the Internal Revenue Code, Regulations, Tax Court and other "trading tax" sites on the internet reveals no authority cited as to why this cannot be performed.  In fact, Sec 475(f)(1)(B) states "If a security ceases to be described in clause (i) - (having no connection to the activities of ... a trader)" the question becomes "How did that investment security "cease" to be an investment security?"
If you look at the MTM implementation process, you will see that any transfers to a MTM trading account subsequent to the electing year violates one of the first steps of electing MTM accounting - the Sec 481(a) adjustment.

 

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A Sec 481(a) adjustment is required for a change in accounting method for the "year of the change" and transferring a security to a MTM trading account would necessitate an adjustment in the basis of the security to FMV, if transferred AFTER the "year of the change".  You are already a MTM trader trading inside a MTM account.  The Sec 481(a) adjustment is not available subsequent to the change in accounting method year.

So the transfer of a security with an unrealized loss into a MTM trading account would require the security to be marked to market BEFORE its transfer.  This means the loss would be recognized as a deemed sale in the investment account then the security transferred into the MTM trading account at its FMV on the date of transfer.

So what about Scenario 2, an unrealized gain in a MTM account being transferred to an investment account?  It would be my opinion that the same requirements regarding revocation of the MTM election, except for the approval by IRS, would control.  Essentially you are revoking MTM for that individual security.  Thus, in that scenario, another "Sec 481(a) adjustment" needs to be made converting that individual security from MTM to the realization method, which would entail the basis adjustment to occur inside the MTM trading account.  The gain would stay inside the MTM account.

 

Bottom-line, this would be an attempt to "have your cake and eat it too!" and would basically be defrauding the government through stock transfer "sleight of hand".  You may not get audited but if you did, the accuracy-related and/or the substantial underpayment penalty may apply,