Section 475 Election Statement Example: What You Need to Know
Learn how to properly draft and file a Section 475 election statement, including key components, timing considerations, and record-keeping requirements.
Traders who buy and sell securities frequently may face complex tax rules, but the Section 475 election can offer significant benefits. This election allows qualifying traders to treat gains and losses as ordinary income rather than capital gains, potentially avoiding the wash sale rule and allowing full deduction of losses in the year they occur.
When You May Need This Election
Frequent traders often deal with short-term gains and losses, which are taxed at ordinary income rates—up to 37% in 2024. Capital losses, however, are limited to a $3,000 annual deduction against ordinary income, with any excess carried forward. This restriction can be problematic for traders with significant losses in a given year.
Electing Section 475 eliminates the capital loss deduction limit, allowing losses to be fully deducted in the year they occur. This provides immediate tax relief rather than requiring traders to carry losses forward. It is particularly beneficial for traders who rely on trading as their primary income source and may not have sufficient future gains to offset carried-forward losses.
Another advantage is avoiding the wash sale rule, which disallows tax deductions for losses on securities repurchased within 30 days. Under Section 475, traders mark their positions to market at year-end, treating them as if they were sold and repurchased at fair market value. This simplifies tax reporting by eliminating the need to track wash sales.
Components of the Election Statement
To elect Section 475, traders must submit a written statement to the IRS by the deadline. This document formally declares the election and must include specific details to be valid.
Statement Declaration
The election statement must explicitly state:
“Pursuant to Section 475(f) of the Internal Revenue Code, I hereby elect to adopt the mark-to-market accounting method for the tax year [insert applicable year].”
This ensures clarity regarding the trader’s intent. The IRS requires this statement to be included with a timely filed tax return or an extension request. If not properly declared, the IRS may reject the election.
Identification of Securities
The statement must specify which securities are covered. Section 475 applies to stocks, bonds, options, and other financial instruments held in a trading business but does not cover personal investment accounts. If a trader has both a personal portfolio and an active trading account, only the trading account qualifies. The statement should clarify this distinction:
“This election applies to all securities held in connection with my trade or business as a trader in securities, excluding any securities held for personal investment purposes.”
Failing to properly identify applicable securities could lead to IRS scrutiny.
Effective Date
The election must specify the tax year it applies to. The IRS requires it to be made by the due date of the prior year’s tax return, without extensions. For example, to apply the election for 2024, a trader must file the election statement by April 15, 2024.
A clear statement should be included:
“This election is effective for the tax year beginning January 1, 2024.”
Once made, the election remains in effect for all subsequent years unless revoked with IRS approval. Without an effective date, the IRS may not recognize the election.
Filing Steps
The election must be attached to a timely filed tax return or extension request for the year preceding the tax year in which it will take effect. For example, to apply the election for 2025, the statement must be included with the 2024 tax return, due by April 15, 2025. Missing this deadline means waiting another year to make the election.
For sole proprietors, the election is filed with Form 1040. Traders using an entity, such as an LLC or S corporation, must file at the entity level. If a trader later changes their business structure, such as converting from a sole proprietorship to an S corporation, a new election may be required.
After filing the election statement, traders must submit Form 3115, “Application for Change in Accounting Method,” in the year the election takes effect. This form notifies the IRS of the switch to mark-to-market accounting and includes a Section 481(a) adjustment to account for unrealized gains or losses on open positions from the prior year. This adjustment ensures the transition does not create an unintended tax advantage or disadvantage.
Record Retention
Traders should keep a copy of the original election statement and the tax return or extension request to which it was attached for at least seven years. The IRS typically audits returns within three years but can extend this to six years if substantial income discrepancies are found.
Beyond the election statement, traders must retain brokerage statements, trade confirmations, and accounting records supporting mark-to-market treatment. Since Section 475 requires year-end fair market value adjustments, detailed records of daily trading activity, open positions, and valuations are necessary to substantiate reported income. Failure to maintain these records could result in the IRS disallowing the election, potentially reclassifying ordinary losses as capital losses, significantly impacting tax liabilities.