One of the first decisions a trader needs to make is what accounting method to use to report their trading activity. The default accounting method is cash accounting however many traders can benefit by electing the mark to market accounting method.
So what is mark to market accounting? What are the benefits of electing this method? MTM refers to a year-end process where you mark all your open positions to market prices. Essentially, you are calculating the sale of all open positions at year-end using the closing price of the last day of trading in that year. This accounting method is available only for those who can qualify as a trader in securities and must be made by April 15.
Now to the benefits, MTM trading gains and losses are considered ordinary gains and losses. This is an amazing benefit as it means that trading losses may be deducted in full against any type of income. Ordinary business losses can also generate net operating losses (NOL) that may be carried back up to five years for immediate tax refunds. You are not limited by the $3,000 capital loss limitation that applies to cash method taxpayers and if you are new to trading, you may experience losses larger than $3,000 and you would like to be able to utilize all your losses in the year you incurred them so you can get your refund back from Uncle Sam fast enough to increase your reduced capital in your trading account.
Profitable traders also benefit by electing MTM, they are exempt from the burdensome wash sale loss deferrals rules that apply to non-MTM traders. For example, you may be profitable for the year, but have hundreds of wash sale transactions during the year. You would not be able to include those in your profit/loss calculation, thus increasing your tax liability substantially.
Should securities traders elect MTM? As you can see, MTM offers many advantages like deducting your trading losses as ordinary losses rather than restricted capital losses. Capital losses may not be carried back for individuals, but MTM can be carried back. MTM also offers a way out of dealing with wash sale rules, saving you time and money.