Section 475(f) Mark-to-Market Elections
Client Alerts | February 8, 2016 | Securities and Corporate Finance | Hedge Funds
A Section 475(f) election might help ease the pain for taxable investors in a fund experiencing losses in 2016 or possibly where a fund has significant unrealized losses coming into 2016. Specifically, Section 475(f) provides that a trader in securities or commodities can make elections to “mark-to-market” their securities and/or commodities and treat increases or decreases in value as ordinary income or loss. An ordinary loss could offset ordinary income and, to the extent not utilized, the ordinary loss would constitute a net operating loss which could be carried back up to two years.
For 2016, for partnerships, the election generally must be made by April 15, 2016 (for new taxpayers that started business on January 1, 2016, the deadline would be 2 months and 15 days after the start of their year – i.e., March 15, 2016). A fund must be a trader, and not an investor, in order to be able to make a Section 475(f) election.
If an election is made for 2016, any net unrealized built-in gain as of December 31, 2015, is generally included evenly in income over 4 years. Any net unrealized built-in loss as of December 31, 2015, is included, in its entirety, in income in 2016. Whether the net unrealized built-in gain or loss is ordinary or capital is not clear but could potentially be treated as ordinary. Any additional appreciation or depreciation in 2016 and later years would be ordinary.
In addition to ordinary characterization for losses, other tax benefits of a Section 475(f) election include avoiding the wash sale rules and the straddle rules.
Recently, there have been indications that the IRS may issue guidance on Section 475(f) elections that may make them prospective only (i.e., no look back to the beginning of the year for a timely made Section 475(f) election) and may address character issues as well. It would seem unlikely, however, that the IRS would not allow 2016 elections made under current rules to be effective January 1, 2016.
Separately, for a partnership taxpayer that already has a Section 475(f) in effect, the taxpayer can revoke its election as of January 1, 2016, by filing a notification statement by April 15, 2016.
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.