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I have traded for most of the year while I work at my full time job as a software developer. I am using it to augment my income. I like working in academia but it just doesn't pay that well! I started in late January and made trades in every month of the year. The median holding time per position was about 3 days (so I was trying to capitalize on short time price swings).

I'm new at trading, so I made some emotional mistakes and if my calculations are right I lost about $5000 I gained about $1400 by the end of 2013. I calculated this by doing the mark to market on 12/31 and subtracting the account balance (~69,200) (~75,900) as of that day from the total amount of cash I've put in (~74,500) as of that day. The numbers above are corrected; I had forgotten to mark my SPY position to market. So my actual gain was ~$1400, but according to my Scottrade tax report, due to the wash sale rules, it looks like I gained $20k! This is punitive.

The only way out that I can see is the mark to market election, but I'm wary of it. I'm not certain I qualify, and I'm not certain I want to KEEP trading every year from now on (I might want to transition to a more traditional investing pattern if there is a big correction in the market). But I am certain I don't want to pay a few thousand dollars of tax on some imaginary gains! :( Does anybody know specifics about how hard it is to get permission from the IRS to come back from the M2M election? And are there any red flags in this scenario which would mean I'm not even eligible for it?

Category                Gross Proceeds Cost Basis     Wash Sale Loss Disallowed  Net Gain/Loss
A (basis reported)      $1,698,367.79  $1,854,734.46  $168,059.55                $11,692.88   
B (basis not reported)  $3,104,256.07  $3,534,153.57  $438,278.99                $8,381.49    
Total                   $4,802,623.86  $5,388,888.03  $606,338.54                $20,074.37   
  • Punitive? I hope you weren't blindsided by the wash rules. It's pretty straightforward. – JoeTaxpayer Apr 10 '14 at 0:18
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    Hi Matt. Could you please add a country tag? It's required when taxes are the subject. Thank you. – Chris W. Rea Apr 10 '14 at 0:31
  • Do other countries have wash sale rules? – JoeTaxpayer Apr 10 '14 at 2:23
  • Wash sale gains? I'm not certain I follow. IRC § 1091 is only about disallowed losses. Are you saying that the disallowed losses are $15k, such that your tax gain is $20k while your economic gain was only $5k? Note that for disallowed wash sale losses you will still get those losses later in your basis when you fully exit the position. They are deferred but not erased. – NL7 Apr 10 '14 at 14:19
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    @JoeTaxpayer We do have a similar rule in Canada but it is more commonly referred to as the superficial loss rule. – Chris W. Rea Apr 10 '14 at 20:28
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If you did not elect mark to market by April 15, 2013, then you cannot claim mark to market for tax year 2013. You were not timely, so the issue is moot for the tax year at issue. See Pub 550 (p 70) or Topic 429. Sorry to bear bad news.

Note that your wash sale losses are only suspended until you exit the stock, so this is not a straight loss. See IRC § 1091(d). They should be included in your basis of the over-traded stock. This is a time value issue, so you lost the value of those losses for 2013 but they still exist, suspended in basis, for 2014 and beyond.

It will preserve your flexibility to avoid mark to market and be a regular investor. You can time your income. The most commonly cited reason to avoid mark to market is of course the phantom income problem - you must sell an investment to find the cash to pay the tax on that investment. That may make sense if you are liquid and seldom hold stocks or investments for long periods. But phantom income is not a fun problem to have and you may find it less convenient than dodging wash sale rules.

  • Yes, I did notice the "timely election" bit in littleadv's link. It's amazing to me that in all my googling about mark to market, that page didn't show up. I was getting 10-15 year old pages which didn't say anything about having to elect for it before the fact (which I assume, back then, was not necessary). I also read there that m2m traders can have normal investments as long as they keep records of which stocks are normal investments (the suggested approach is a separate brokerage account). Wouldn't that avoid the phantom income problem? – Matt Chambers Apr 10 '14 at 15:57
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    I usually add "irs.gov" when doing a google search on taxes. There's also a complete listing of all the official IRS Publications here: irs.gov/publications/index.html?RefNo=635206387959453234. There are also multiple places to look at the internal revenue code for free, but apparently most people don't enjoy reading through the tax code. – NL7 Apr 10 '14 at 16:00
  • I'm afraid I don't understand 1091(d). Is it saying that for my FB trading, which I haven't had a position in for a while, and resulted in a net loss of ~17000 (ouch!), the wash sale losses should no longer count? I'm not sure what "time value" issue means. – Matt Chambers Apr 10 '14 at 16:01
  • I'm not sure about electing mark to market for only some activities and not others. I mostly know taxation of derivatives from the corporate perspective, not the traders. I'll poke around and see if I notice something. Pub 550 would be the place to look. – NL7 Apr 10 '14 at 16:03
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    §1091(a) disallows losses from a wash sale, which occurs if a purchase happens within +30 or -30 days of a sale of the same stock. §1091(d) puts the disallowed loss into the basis of that stock. So you still get the tax benefit, but only when you fully the exit the stock. This prevents you from electively recognizing losses by overlapping purchases and sales of the same stock. The time value problem is that a dollar of tax benefit in 2014 is more valuable than a dollar of tax benefit in 2015. investopedia.com/terms/t/timevalueofmoney.asp – NL7 Apr 10 '14 at 16:10
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Here are the details. Whether it is hard to get the permission to revoke the election is hard to tell, since no-one can tell the future. Form 3115 is filed routinely by tax professionals to request changes in accounting methods. It may trigger an audit if you only use it for one year and have substantial losses that would not otherwise be allowed. If you qualify for the trader terms - then you just show it during the audit.

I would suggest getting a professional help you here. The main pitfall I see is the requirement for the activity to be substantial. $5K profit and $70K overall balance doesn't strike me as substantial for a software engineer (i.e.: I expect your overall income is significantly more than those $5K). But I'm not a tax professional and definitely not an IRS revenue agent, so what the heck do I know...

  • I've thought about professional help, but I'm worried about how much qualified help would cost. I'm worried that run of the mill tax advisers wouldn't really know about mark to market. And this would be the first year I've needed anything more than 1040EZ, so the first time I've needed professional help. – Matt Chambers Apr 10 '14 at 15:54
  • @Matt you got more than enough here for free from NL7 and myself, but in the end - you get what you paid for. If the matter is complicated and a lot of money is at stake - being cheap may turn out very costly. – littleadv Apr 10 '14 at 19:22

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