Deducting Financial Market Losses

ThinkstockPhotos-456620391 - resized

Everyone knows that it’s impossible to predict the stock market, making it essential to learn the best way to write off any losses.

So, while some investors are on the lookout for buying opportunities, others are more cautious this time around – and don’t want to catch a falling knife.

Here we break down some ways investors can maximize their losses on their tax returns.

  • Elect Section 475 for unlimited ordinary losses

If you qualify for trader tax status and are trading as a business activity, you’re entitled to make a timely Section 475 MTM election. Section 475 trades are reported on Form 4797 Part II ordinary gain or loss tax treatment. Exempt from capital-loss limitations and wash-sale loss deferral rules are ordinary losses. This is important to keep in mind, because many traders and tax advisors aren’t experienced with Section 475 and TTS, meaning they miss filling a 2015 election by April 15, 2015 for existing individuals and partnerships or March 15 for existing S-Corps.

New entities “new taxpayers” can elect Section 475 within 75 days of inception. However, pre-entity losses remain capital losses, so it’s important to wait the 75 days to decide whether to elect 475 internally or not.

  • Net operating losses generate tax refunds

Section 475 ordinary losses reduce gross income without any limitation. For example, if you have negative taxable income, Section 475 losses are includible in a net operating loss (NOL) tax computation. NOLs can be carried back two tax years and/or forward 20 years. Additionally, NOLs offset all types of income.

  • Wash sale losses require careful management

Taking a loss on a security in a taxable account, and buying a substantially identical position back 30 days before or after in any individual accounts – including IRAs, is considered to be a wash-sale loss. When it comes to taxable accounts, it’s a deferral with adding the wash-sale loss adjustment to the replacement position’s cost-basis.

  • Section 1256 loss carry back election

Generally, capital losses may never be carried back like NOLs. However, there is one exception: Section 1256 contract losses may be carried back three tax years, but applied only against Section 1256 gains in those years prior.

Included in Section 1256 contracts are:

– Regulated futures contracts (RFCs)

– Broad-based indexes like e-minis

– Options on futures

– Options on indexes

– Non-equity options

  • Forex losses are ordinary by default

Spot forex trading losses in the Interbank market are Section 988 ordinary gain or loss treatment, which means they aren’t subject to capital-loss limitation or wash-sale loss.  It’s important to keep in mind that if you have negative taxable income caused by forex trading losses, you need trader tax status to have NOL treatment – without it, you’ll waste part or all of your forex loss, because it’s not a capital loss carryover.

To learn more details about deducting financial market losses, and to read the entire article, please visit