Mark-to-Market Election – Whether to Make or Revoke a Section 475(f) Election on or Before March 15, 2022
Each year, we send an annual newsletter to our clients and friends regarding Section 475(f) mark-to-market elections. A 475(f) election must be made by partnerships early in the year (by March 15, 2022, for 2022) and can be overlooked while people are focused on preparing tax returns and K-1 estimates for the prior year. A 475(f) election generally offers traders in securities or commodities a way to convert what would otherwise be capital losses into ordinary losses, which are not subject to the same limitations as capital losses and may be used to offset other income.
Section 475(f) of the Internal Revenue Code of 1986, as amended, provides that a trader in securities or commodities may elect to “mark-to-market” its securities and/or commodities positions and treat any appreciation or depreciation as ordinary income or loss. A fund that is an investor is not eligible to make a Section 475(f) election.
An existing calendar year partnership must make its election for 2022 no later than March 15, 2022. New taxpayers must make the election no later than two months and 15 days after the start of their year (i.e., March 15, 2022, for new taxpayers that started on January 1, 2022).
The determination of whether to make a Section 475(f) election became more complicated after the Tax Cuts and Jobs Act of 2017 (the “TCJA”). Net operating losses can no longer be carried back and may only offset up to 80% of income when carried forward. Further, the TCJA also enacted limitations on excess business losses which may also be applicable.
A Section 475(f) election may be beneficial for a fund experiencing losses in 2022 or possibly where a fund has significant net unrealized losses coming into 2022.
For losses in 2022, and possibly for net unrealized losses as of December 31, 2021, such losses could be converted into ordinary losses and taken in 2022 (regardless of when the positions are sold).
An additional benefit of the Section 475(f) election is that you will no longer be subject to the wash sale and straddle rules.
A Section 475(f) election may also be beneficial to a fund that has significant unrealized net gains coming into 2022. For gains in 2022, and possibly for net unrealized gains as of December 31, 2021, such gains might be converted to ordinary (which would generally be disadvantageous), but the net unrealized gain as of December 31, 2021, would be included in income evenly over four years (that is, 25% each year for 2022 through 2025, regardless of when the income is actually realized). Even if the election converts long-term capital gains to ordinary income, the deferral benefit may outweigh the character cost (depending on when the positions would otherwise have been sold). However, an increase in tax rates during such time frame would reduce the benefit.
A partnership can generally make a Section 475 election as of January 1, 2022, and revoke the election in 2023 (by March 15, 2023) effective as of January 1, 2023.
Conversely, a partnership that already has a Section 475(f) in effect can revoke its election as of January 1, 2022, by revoking its election by March 15, 2022. Any appreciation (and depreciation) after December 31, 2021, would be treated as capital gain (or loss) but the holding period might include the period the securities were held by the partnership while the partnership was subject to a Section 475(f) election.
Section 475 has many nuances and a Section 475(f) election should be made or revoked only after careful consideration and consultation with your tax advisors regarding the impact on your fund and its investors.
If you have any questions regarding this client alert, please contact your primary Kleinberg Kaplan attorney or a member of our Tax Department listed to the right.