In Obayagbona v. Commissioner (T.C. Summ. Op. 2016-72), the Tax Court held that a taxpayer could not account for securities by marking to market under Section 475(f)(1). The court held that losses on securities were capital. Significantly, the return for the first year in which the taxpayer claimed to have made the election was not available.

Facts

The taxpayer filed Forms 4797, Sales of Business Property, with his 2008 and 2009 Federal income tax returns to report ordinary losses from stock trading activities, based on the mark-to-market method of accounting. The IRS issued a notice of deficiency to the taxpayer recharacterizing the stock trading losses incurred by the taxpayer in 2008 and 2009 from ordinary to capital losses.

The taxpayer claimed at trial that a Section 475(f) election was made with his 2003 Federal income tax return. Therefore he claimed that he is entitled to use the mark-to-market method of accounting for gains or losses realized in sales of stocks and securities and that any resulting gains and losses were ordinary.

The taxpayer's 2003 Federal income tax return was not available. To determine whether the proper election was made, the Tax Court also reviewed the taxpayer's 2004 - 2009 Federal income tax returns. The 2005 — 2009 returns suggested that the taxpayer made a Section 475(f) mark-to-market election. The reporting of the securities transactions on the taxpayer's 2004 return was inconsistent with the mark-to-market method of accounting.

The court also considered whether the taxpayer was a trader in securities based on the transactions executed during the two years before the court. The court observed that the taxpayer had executed less than 300 trades in each of the two years at issue.

Analysis

Under Section 475(f)(1), a taxpayer that is a "trader in securities" may generally elect to apply the mark-to-market method of accounting to securities held in connection with that trading. Under the mark-to-market method of accounting, gains or losses on the securities are measured at the close of business for the tax year as if the securities were sold for fair market value at that time.

If the election is properly made, any net loss from the business of trading in securities will be treated as an ordinary loss deductible under Section 165(c)(1). If the election is not made, under Section 165 (a), (c) and (f), an individual can deduct any capital loss only to the extent of any capital gains plus $3,000.

The IRS prescribed procedures for making the mark to market election in Revenue Procedure 99-17. To make the election, a taxpayer must file a statement electing the mark-to-market accounting method no later than the unextended due date for the tax return for the year immediately preceding the election year, and must attach the statement to the tax return or to a request for an extension of time to file that return. A trader who fails to adhere to the election requirements of the revenue procedure is not entitled to use the mark-to-market method of accounting.

The court found several reasons that the taxpayer was not entitled to use the mark-to-market method of accounting, and noted that any one reason is sufficient to deny the use of the method. The court noted that the return on which the taxpayer claims to have made the mark-to-market election is not available. In addition, the claim that the election was made in 2003 is inconsistent with the way the securities transactions were reported in 2004. In addition, the Tax Court looked at other cases to determine whether the level of trading that the taxpayer engaged in were sufficient to qualify him as a "trader" and found taxpayer's trading activities were insufficient.¹

Implications

This case emphasizes the importance of retaining documentation that a Section 475(f) election was properly made. A taxpayer should also be aware of the definition of a "trader" for purposes of making a valid election. Furthermore, the decision affirms continuing qualification as a requirement to maintain the trader-in-securities election, underscoring the need to continuously check for trader status.

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ENDNOTES

¹ Endicott v. Commissioner, T.C. Memo. 2013-199 (204 executed trades and 303 executed trades was not substantial, but 1,543 executed trades was substantial); see also Kay v. Commissioner, T.C. Memo. 2011-159 (313 executed trades was not substantial); Holsinger v. Commissioner, T.C. Memo. 2008-191 (372 executed trades was not substantial). This taxpayer executed fewer than 300 trades in each of 2008 and 2009.