The Pros and Cons of Mark to Market

PROS:

If you are a active trader in securities or commodities, with a mark-to-market election in effect for the current tax year, then the following benefits can be yours:

• Gains and losses from all securities or commodities held in connection with your trading business are treated as ordinary income and losses, instead of capital gains and losses.
  
  Normally, if your capital losses exceed your capital gains, the amount of the excess loss that can be claimed is limited by the IRS to $3,000 (or $1,500 if you are married filing separately). If your net capital loss is more than this limit, you can carry the loss forward to later years.  Now imagine a year where you lost $100,000!  How many years would it take to recoup that at a rate of $3,000 per year?
  
  With MTM status the limitation on capital losses do not apply. Therefore, if you had such a substantial loss, you may deduct this loss against all other types of taxable income without the normal $3000 loss limitation.

• Mark to Market accounting provide a type of "tax loss insurance" as losses can be carried back two tax years. This is great news for active traders, who may have made a killing for one or more years only to have a substantial loss the following year.  If you have no other income to offset  this large loss, you may amend the previous two years tax returns and get a refund! No one likes to lose money, but knowing you have some recourse to recoup some of those losses in case you do is quite comforting.

• The wash sale rule does not apply to securities or commodities held in connection with your trading business when you have MTM trading status. This is also great news for active traders and may save quite a bit of heartache come tax time - see our Wash Sales: How they affect me trader tax topic.

CONS:

Mark to Market accounting is not without some downside. For example, if you have a large unrealized gain at year end in one or more of your open positions, you are forced to close those positions (on paper) using the year end prices which increases your current year taxable gain. This is true whether you are long or short.  Normally you do not realize gains until you actually close your positions, so be aware of this at year end if you have elected MTM.

You must qualify and then elect for MTM method before you simply change your accounting method. Read more to learn how to elect MTM.