Trader Accounting: Mark-to-Market, Section 1256, and Depreciation

Trading taxes are not investment taxes. A trader who files as an investor overpays and loses deductions; a trader who elects the wrong status triggers audit risk. The three accounting decisions below determine after-tax returns more than most strategy choices.

Investor vs trader vs dealer (US context)

The IRS distinguishes three statuses, each with different treatment:

• Investor: capital gains, long-term rates available, losses limited to $3,000/year against ordinary income.
• Trader in securities: Schedule C for expenses (no itemizing), but gains still capital, $3,000 loss limit still applies.
• Trader with Section 475(f) mark-to-market election: gains and losses ordinary, no $3,000 wash-sale limit, unrealized gains marked to market at year-end.

Trader status requires "substantial" activity — typically 5+ trades per week, holding periods of hours to days, and trading as a primary activity. The IRS tests frequency, volume, and intent to profit from short-term moves.

The Section 475(f) election

Mark-to-market converts all positions to ordinary income/loss at year-end fair value. Benefits: no wash-sale rule headaches, full loss deduction against ordinary income, no carryover. Costs: no long-term capital gains rates ever, election is irrevocable without IRS consent.

Make the election by April 15 of the tax year (not the filing deadline of the next year). Missing the date means waiting a full year. This is the single most-missed deadline in trader tax planning.

Section 1256 contracts

Futures and options on futures get 60/40 treatment: 60% long-term, 40% short-term capital gains, regardless of holding period. Plus they are marked to market at year-end automatically. A profitable futures trader often pays less tax under 1256 than under 475, because the 60% long-term blend is below ordinary rates.

A trader mixing securities and futures must reconcile two systems: 475 on the securities, 1256 on the futures. Keep separate ledgers from day one.

Depreciation of trading equipment

Traders can depreciate business equipment on Schedule C (or entity return):

• Computers and monitors: 3-year or 5-year MACRS, or Section 179 expensing up to the annual limit (currently ~$1.2M).
• Trading desk and chair: 7-year MACRS.
• Software subscriptions: expensed in the year paid (not depreciated).
• Home office: deductible if used regularly and exclusively for trading; the simplified method is $5/sq ft up to 300 sq ft.

Record-keeping that survives audit

• Separate trading bank and brokerage accounts from personal.
• Log every trade with entry, exit, and holding period; broker 1099s do not capture wash sales correctly across accounts.
• Reconcile realized P&L monthly; year-end reconstruction is error-prone.
• Keep data feed and software invoices — they are deductible and frequently challenged.

The practical guidance

Elect trader status only if you genuinely qualify and trade actively. Elect 475 only if you have consistent losses that exceed $3,000 (the wash-sale relief matters) or trade heavily with short holding periods. For most active futures traders, 1256 treatment without 475 is the better default. Run the numbers with a trader-savvy CPA before electing — the wrong election costs 5–15% of annual returns.